G.R. No.

153793 August 29, 2006

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.
JULIANE BAIER-NICKEL, as represented by Marina Q. Guzman (Attorney-in-fact) Respondent.

DECISION

YNARES-SANTIAGO, J.:

1
Petitioner Commissioner of Internal Revenue (CIR) appeals from the January 18, 2002 Decision of the Court of Appeals in CA-G.R. SP No.
2
59794, which granted the tax refund of respondent Juliane Baier-Nickel and reversed the June 28, 2000 Decision of the Court of Tax Appeals
3
(CTA) in C.T.A. Case No. 5633. Petitioner also assails the May 8, 2002 Resolution of the Court of Appeals denying its motion for
reconsideration.

The facts show that respondent Juliane Baier-Nickel, a non-resident German citizen, is the President of JUBANITEX, Inc., a domestic corporation
engaged in "[m]anufacturing, marketing on wholesale only, buying or otherwise acquiring, holding, importing and exporting, selling and
4
disposing embroidered textile products." Through JUBANITEXs General Manager, Marina Q. Guzman, the corporation appointed and engaged
the services of respondent as commission agent. It was agreed that respondent will receive 10% sales commission on all sales actually
5
concluded and collected through her efforts.

In 1995, respondent received the amount of P1,707,772.64, representing her sales commission income from which JUBANITEX withheld the
corresponding 10% withholding tax amounting to P170,777.26, and remitted the same to the Bureau of Internal Revenue (BIR). On October 17,
6
1997, respondent filed her 1995 income tax return reporting a taxable income of P1,707,772.64 and a tax due of P170,777.26.

On April 14, 1998, respondent filed a claim to refund the amount of P170,777.26 alleged to have been mistakenly withheld and remitted by
JUBANITEX to the BIR. Respondent contended that her sales commission income is not taxable in the Philippines because the same was a
compensation for her services rendered in Germany and therefore considered as income from sources outside the Philippines.

The next day, April 15, 1998, she filed a petition for review with the CTA contending that no action was taken by the BIR on her claim for
7
refund. On June 28, 2000, the CTA rendered a decision denying her claim. It held that the commissions received by respondent were actually
her remuneration in the performance of her duties as President of JUBANITEX and not as a mere sales agent thereof. The income derived by
respondent is therefore an income taxable in the Philippines because JUBANITEX is a domestic corporation.

On petition with the Court of Appeals, the latter reversed the Decision of the CTA, holding that respondent received the commissions as sales
agent of JUBANITEX and not as President thereof. And since the "source" of income means the activity or service that produce the income, the
sales commission received by respondent is not taxable in the Philippines because it arose from the marketing activities performed by
respondent in Germany. The dispositive portion of the appellate courts Decision, reads:

WHEREFORE, premises considered, the assailed decision of the Court of Tax Appeals dated June 28, 2000 is hereby REVERSED and SET ASIDE
and the respondent court is hereby directed to grant petitioner a tax refund in the amount of Php 170,777.26.

8
SO ORDERED.

9
Petitioner filed a motion for reconsideration but was denied. Hence, the instant recourse.

Petitioner maintains that the income earned by respondent is taxable in the Philippines because the source thereof is JUBANITEX, a domestic
corporation located in the City of Makati. It thus implied that source of income means the physical source where the income came from. It
further argued that since respondent is the President of JUBANITEX, any remuneration she received from said corporation should be construed
as payment of her overall managerial services to the company and should not be interpreted as a compensation for a distinct and separate
service as a sales commission agent.

Respondent, on the other hand, claims that the income she received was payment for her marketing services. She contended that income of
nonresident aliens like her is subject to tax only if the source of the income is within the Philippines. Source, according to respondent is
the situs of the activity which produced the income. And since the source of her income were her marketing activities in Germany, the income
she derived from said activities is not subject to Philippine income taxation.

The issue here is whether respondents sales commission income is taxable in the Philippines.

Pertinent portion of the National Internal Revenue Code (NIRC), states:

SEC. 25. Tax on Nonresident Alien Individual.

(A) Nonresident Alien Engaged in Trade or Business Within the Philippines.

(1) In General. A nonresident alien individual engaged in trade or business in the Philippines shall be subject to an income tax in the same
manner as an individual citizen and a resident alien individual, on taxable income received from all sources within the Philippines. A
nonresident alien individual who shall come to the Philippines and stay therein for an aggregate period of more than one hundred eighty (180)
days during any calendar year shall be deemed a nonresident alien doing business in the Philippines, Section 22(G) of this Code
notwithstanding.
xxxx

(B) Nonresident Alien Individual Not Engaged in Trade or Business Within the Philippines. There shall be levied, collected and paid for each
taxable year upon the entire income received from all sources within the Philippines by every nonresident alien individual not engaged in trade
or business within the Philippines x x x a tax equal to twenty-five percent (25%) of such income. x x x

Pursuant to the foregoing provisions of the NIRC, non-resident aliens, whether or not engaged in trade or business, are subject to Philippine
income taxation on their income received from all sources within the Philippines. Thus, the keyword in determining the taxability of non-
resident aliens is the incomes "source." In construing the meaning of "source" in Section 25 of the NIRC, resort must be had on the origin of
the provision.

10 11
The first Philippine income tax law enacted by the Philippine Legislature was Act No. 2833, which took effect on January 1, 1920. Under
Section 1 thereof, nonresident aliens are likewise subject to tax on income "from all sources within the Philippine Islands," thus

SECTION 1. (a) There shall be levied, assessed, collected, and paid annually upon the entire net income received in the preceding calendar year
from all sources by every individual, a citizen or resident of the Philippine Islands, a tax of two per centum upon such income; and a like tax
shall be levied, assessed, collected, and paid annually upon the entire net income received in the preceding calendar year from all sources
within the Philippine Islands by every individual, a nonresident alien, including interest on bonds, notes, or other interest-bearing obligations of
residents, corporate or otherwise.

12
Act No. 2833 substantially reproduced the United States (U.S.) Revenue Law of 1916 as amended by U.S. Revenue Law of 1917. Being a law of
American origin, the authoritative decisions of the official charged with enforcing it in the U.S. have peculiar persuasive force in the
13
Philippines.

The Internal Revenue Code of the U.S. enumerates specific types of income to be treated as from sources within the U.S. and specifies when
14
similar types of income are to be treated as from sources outside the U.S. Under the said Code, compensation for labor and personal services
performed in the U.S., is generally treated as income from U.S. sources; while compensation for said services performed outside the U.S., is
15
treated as income from sources outside the U.S. A similar provision is found in Section 42 of our NIRC, thus:

SEC. 42. x x x

(A) Gross Income From Sources Within the Philippines. x x x

xxxx

(3) Services. Compensation for labor or personal services performed in the Philippines;

xxxx

(C) Gross Income From Sources Without the Philippines. x x x

xxxx

(3) Compensation for labor or personal services performed without the Philippines;

The following discussions on sourcing of income under the Internal Revenue Code of the U.S., are instructive:

The Supreme Court has said, in a definition much quoted but often debated, that income may be derived from three possible sources only: (1)
capital and/or (2) labor; and/or (3) the sale of capital assets. While the three elements of this attempt at definition need not be accepted as all-
inclusive, they serve as useful guides in any inquiry into whether a particular item is from "sources within the United States" and suggest an
investigation into the nature and location of the activities or property which produce the income.

If the income is from labor the place where the labor is done should be decisive; if it is done in this country, the income should be from
"sources within the United States." If the income is from capital, the place where the capital is employed should be decisive; if it is employed in
this country, the income should be from "sources within the United States." If the income is from the sale of capital assets, the place where the
sale is made should be likewise decisive.

Much confusion will be avoided by regarding the term "source" in this fundamental light. It is not a place, it is an activity or property. As such, it
has a situs or location, and if that situs or location is within the United States the resulting income is taxable to nonresident aliens and foreign
corporations.

The intention of Congress in the 1916 and subsequent statutes was to discard the 1909 and 1913 basis of taxing nonresident aliens and foreign
corporations and to make the test of taxability the "source," or situs of the activities or property which produce the income. The result is that,
on the one hand, nonresident aliens and nonresident foreign corporations are prevented from deriving income from the United States free
from tax, and, on the other hand, there is no undue imposition of a tax when the activities do not take place in, and the property producing
income is not employed in, this country. Thus, if income is to be taxed, the recipient thereof must be resident within the jurisdiction, or the
property or activities out of which the income issues or is derived must be situated within the jurisdiction so that the source of the income may
be said to have a situs in this country.
The underlying theory is that the consideration for taxation is protection of life and property and that the income rightly to be levied upon to
defray the burdens of the United States Government is that income which is created by activities and property protected by this Government
16
or obtained by persons enjoying that protection.

The important factor therefore which determines the source of income of personal services is not the residence of the payor, or the place
17
where the contract for service is entered into, or the place of payment, but the place where the services were actually rendered.

18
In Alexander Howden & Co., Ltd. v. Collector of Internal Revenue, the Court addressed the issue on the applicable source rule relating to
reinsurance premiums paid by a local insurance company to a foreign insurance company in respect of risks located in the Philippines. It was
held therein that the undertaking of the foreign insurance company to indemnify the local insurance company is the activity that produced the
income. Since the activity took place in the Philippines, the income derived therefrom is taxable in our jurisdiction. Citing Mertens, The Law of
Federal Income Taxation, the Court emphasized that the technical meaning of source of income is the property, activity or service that
produced the same. Thus:

The source of an income is the property, activity or service that produced the income. The reinsurance premiums remitted to appellants by
virtue of the reinsurance contracts, accordingly, had for their source the undertaking to indemnify Commonwealth Insurance Co. against
liability. Said undertaking is the activity that produced the reinsurance premiums, and the same took place in the Philippines. x x x the
reinsured, the liabilities insured and the risk originally underwritten by Commonwealth Insurance Co., upon which the reinsurance premiums
19
and indemnity were based, were all situated in the Philippines. x x x

20
In Commissioner of Internal Revenue v. British Overseas Airways Corporation (BOAC), the issue was whether BOAC, a foreign airline company
which does not maintain any flight to and from the Philippines is liable for Philippine income taxation in respect of sales of air tickets in the
Philippines, through a general sales agent relating to the carriage of passengers and cargo between two points both outside the Philippines.
Ruling in the affirmative, the Court applied the case of Alexander Howden & Co., Ltd. v. Collector of Internal Revenue, and reiterated the rule
that the source of income is that "activity" which produced the income. It was held that the "sale of tickets" in the Philippines is the "activity"
that produced the income and therefore BOAC should pay income tax in the Philippines because it undertook an income producing activity in
the country.

Both the petitioner and respondent cited the case of Commissioner of Internal Revenue v. British Overseas Airways Corporation in support of
their arguments, but the correct interpretation of the said case favors the theory of respondent that it is the situs of the activity that
determines whether such income is taxable in the Philippines. The conflict between the majority and the dissenting opinion in the said case has
nothing to do with the underlying principle of the law on sourcing of income. In fact, both applied the case of Alexander Howden & Co., Ltd. v.
Collector of Internal Revenue. The divergence in opinion centered on whether the sale of tickets in the Philippines is to be construed as the
"activity" that produced the income, as viewed by the majority, or merely the physical source of the income, as ratiocinated by Justice
Florentino P. Feliciano in his dissent. The majority, through Justice Ameurfina Melencio-Herrera, as ponente, interpreted the sale of tickets as a
business activity that gave rise to the income of BOAC. Petitioner cannot therefore invoke said case to support its view that source of income is
the physical source of the money earned. If such was the interpretation of the majority, the Court would have simply stated that source of
income is not the business activity of BOAC but the place where the person or entity disbursing the income is located or where BOAC physically
received the same. But such was not the import of the ruling of the Court. It even explained in detail the business activity undertaken by BOAC
in the Philippines to pinpoint the taxable activity and to justify its conclusion that BOAC is subject to Philippine income taxation. Thus

BOAC, during the periods covered by the subject assessments, maintained a general sales agent in the Philippines. That general sales agent,
from 1959 to 1971, "was engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series of trips each trip in the series
corresponding to a different airline company; (3) receiving the fare from the whole trip; and (4) consequently allocating to the various airline
companies on the basis of their participation in the services rendered through the mode of interline settlement as prescribed by Article VI of
the Resolution No. 850 of the IATA Agreement." Those activities were in exercise of the functions which are normally incident to, and are in
progressive pursuit of, the purpose and object of its organization as an international air carrier. In fact, the regular sale of tickets, its main
activity, is the very lifeblood of the airline business, the generation of sales being the paramount objective. There should be no doubt then that
21
BOAC was "engaged in" business in the Philippines through a local agent during the period covered by the assessments. x x x

xxxx

The source of an income is the property, activity or service that produced the income. For the source of income to be considered as coming
from the Philippines, it is sufficient that the income is derived from activity within the Philippines. In BOAC's case, the sale of tickets in the
Philippines is the activity that produces the income. The tickets exchanged hands here and payments for fares were also made here in
Philippine currency. The situs of the source of payments is the Philippines. The flow of wealth proceeded from, and occurred within, Philippine
territory, enjoying the protection accorded by the Philippine government. In consideration of such protection, the flow of wealth should share
the burden of supporting the government.

A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the contract between the ticket-holder
and the carrier. It gives rise to the obligation of the purchaser of the ticket to pay the fare and the corresponding obligation of the carrier to
transport the passenger upon the terms and conditions set forth thereon. The ordinary ticket issued to members of the traveling public in
22
general embraces within its terms all the elements to constitute it a valid contract, binding upon the parties entering into the relationship.

The Court reiterates the rule that "source of income" relates to the property, activity or service that produced the income. With respect to
rendition of labor or personal service, as in the instant case, it is the place where the labor or service was performed that determines the
source of the income. There is therefore no merit in petitioners interpretation which equates source of income in labor or personal service
with the residence of the payor or the place of payment of the income.

Having disposed of the doctrine applicable in this case, we will now determine whether respondent was able to establish the factual
circumstances showing that her income is exempt from Philippine income taxation.
The decisive factual consideration here is not the capacity in which respondent received the income, but the sufficiency of evidence to prove
that the services she rendered were performed in Germany. Though not raised as an issue, the Court is clothed with authority to address the
23
same because the resolution thereof will settle the vital question posed in this controversy.

24
The settled rule is that tax refunds are in the nature of tax exemptions and are to be construed strictissimi jurisagainst the taxpayer. To those
therefore, who claim a refund rest the burden of proving that the transaction subjected to tax is actually exempt from taxation.

In the instant case, the appointment letter of respondent as agent of JUBANITEX stipulated that the activity or the service which would entitle
25
her to 10% commission income, are "sales actually concluded and collected through [her] efforts." What she presented as evidence to prove
that she performed income producing activities abroad, were copies of documents she allegedly faxed to JUBANITEX and bearing instructions
as to the sizes of, or designs and fabrics to be used in the finished products as well as samples of sales orders purportedly relayed to her by
clients. However, these documents do not show whether the instructions or orders faxed ripened into concluded or collected sales in Germany.
At the very least, these pieces of evidence show that while respondent was in Germany, she sent instructions/orders to JUBANITEX. As to
whether these instructions/orders gave rise to consummated sales and whether these sales were truly concluded in Germany, respondent
presented no such evidence. Neither did she establish reasonable connection between the orders/instructions faxed and the reported monthly
sales purported to have transpired in Germany.

The paucity of respondents evidence was even noted by Atty. Minerva Pacheco, petitioners counsel at the hearing before the Court of Tax
Appeals. She pointed out that respondent presented no contracts or orders signed by the customers in Germany to prove the sale transactions
26
therein. Likewise, in her Comment to the Formal Offer of respondents evidence, she objected to the admission of the faxed documents
27 28 29
bearing instruction/orders marked as Exhibits "R," "V," "W", and "X," for being self serving. The concern raised by petitioners counsel as
to the absence of substantial evidence that would constitute proof that the sale transactions for which respondent was paid commission
actually transpired outside the Philippines, is relevant because respondent stayed in the Philippines for 89 days in 1995. Except for the months
30
of July and September 1995, respondent was in the Philippines in the months of March, May, June, and August 1995, the same months when
she earned commission income for services allegedly performed abroad. Furthermore, respondent presented no evidence to prove that
JUBANITEX does not sell embroidered products in the Philippines and that her appointment as commission agent is exclusivelyfor Germany and
other European markets.

In sum, we find that the faxed documents presented by respondent did not constitute substantial evidence, or that relevant evidence that a
31
reasonable mind might accept as adequate to support the conclusion that it was in Germany where she performed the income producing
service which gave rise to the reported monthly sales in the months of March and May to September of 1995. She thus failed to discharge the
burden of proving that her income was from sources outside the Philippines and exempt from the application of our income tax law. Hence, the
claim for tax refund should be denied.

32
The Court notes that in Commissioner of Internal Revenue v. Baier-Nickel, a previous case for refund of income withheld from respondents
33
remunerations for services rendered abroad, the Court in a Minute Resolution dated February 17, 2003, sustained the ruling of the Court of
Appeals that respondent is entitled to refund the sum withheld from her sales commission income for the year 1994. This ruling has no bearing
in the instant controversy because the subject matter thereof is the income of respondent for the year 1994 while, the instant case deals with
her income in 1995. Otherwise, stated, res judicata has no application here. Its elements are: (1) there must be a final judgment or order; (2)
the court that rendered the judgment must have jurisdiction over the subject matter and the parties; (3) it must be a judgment on the merits;
34
(4) there must be between the two cases identity of parties, of subject matter, and of causes of action. The instant case, however, did not
satisfy the fourth requisite because there is no identity as to the subject matter of the previous and present case of respondent which deals
with income earned and activities performed for different taxable years.

WHEREFORE, the petition is GRANTED and the January 18, 2002 Decision and May 8, 2002 Resolution of the Court of Appeals in CA-G.R. SP No.
59794, are REVERSED and SET ASIDE. The June 28, 2000 Decision of the Court of Tax Appeals in C.T.A. Case No. 5633, which denied
respondents claim for refund of income tax paid for the year 1995 is REINSTATED.

SO ORDERED.

G.R. No. L-53961

NATIONAL DEVELOPMENT COMPANY, petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.

CRUZ, J.:

We are asked to reverse the decision of the Court of Tax Appeals on the ground that it is erroneous. We have carefully studied it and find it is
not; on the contrary, it is supported by law and doctrine. So finding, we affirm.

Reduced to simplest terms, the background facts are as follows.

The national Development Company entered into contracts in Tokyo with several Japanese shipbuilding companies for the construction of
1 2
twelve ocean-going vessels. The purchase price was to come from the proceeds of bonds issued by the Central Bank. Initial payments were
3
made in cash and through irrevocable letters of credit. Fourteen promissory notes were signed for the balance by the NDC and, as required by
4
the shipbuilders, guaranteed by the Republic of the Philippines. Pursuant thereto, the remaining payments and the interests thereon were
5
remitted in due time by the NDC to Tokyo. The vessels were eventually completed and delivered to the NDC in Tokyo.

The NDC remitted to the shipbuilders in Tokyo the total amount of US$4,066,580.70 as interest on the balance of the purchase price. No tax
was withheld. The Commissioner then held the NDC liable on such tax in the total sum of P5,115,234.74. Negotiations followed but failed. The
6
BIR thereupon served on the NDC a warrant of distraint and levy to enforce collection of the claimed amount. The NDC went to the Court of
Tax Appeals.

The BIR was sustained by the CTA except for a slight reduction of the tax deficiency in the sum of P900.00, representing the compromise
7
penalty. The NDC then came to this Court in a petition for certiorari.

The petition must fail for the following reasons.

The Japanese shipbuilders were liable to tax on the interest remitted to them under Section 37 of the Tax Code, thus:

SEC. 37. Income from sources within the Philippines. (a) Gross income from sources within the Philippines. The following items of
gross income shall be treated as gross income from sources within the Philippines:

(1) Interest. Interest derived from sources within the Philippines, and interest on bonds, notes, or other interest-bearing
obligations of residents, corporate or otherwise;

xxx xxx xxx

The petitioner argues that the Japanese shipbuilders were not subject to tax under the above provision because all the related activities the
signing of the contract, the construction of the vessels, the payment of the stipulated price, and their delivery to the NDC were done in
8
Tokyo. The law, however, does not speak of activity but of "source," which in this case is the NDC. This is a domestic and resident corporation
with principal offices in Manila.

As the Tax Court put it:

It is quite apparent, under the terms of the law, that the Government's right to levy and collect income tax on interest received by
foreign corporations not engaged in trade or business within the Philippines is not planted upon the condition that 'the activity or
labor and the sale from which the (interest) income flowed had its situs' in the Philippines. The law specifies: 'Interest derived from
sources within the Philippines, and interest on bonds, notes, or other interest-bearing obligations of residents, corporate or
otherwise.' Nothing there speaks of the 'act or activity' of non-resident corporations in the Philippines, or place where the contract is
signed. The residence of the obligor who pays the interest rather than the physical location of the securities, bonds or notes or the
place of payment, is the determining factor of the source of interest income. (Mertens, Law of Federal Income Taxation, Vol. 8, p.
128, citing A.C. Monk & Co. Inc. 10 T.C. 77; Sumitomo Bank, Ltd., 19 BTA 480; Estate of L.E. Mckinnon, 6 BTA 412; Standard Marine
Ins. Co., Ltd., 4 BTA 853; Marine Ins. Co., Ltd., 4 BTA 867.) Accordingly, if the obligor is a resident of the Philippines the interest
payment paid by him can have no other source than within the Philippines. The interest is paid not by the bond, note or other
interest-bearing obligations, but by the obligor. (See mertens, Id., Vol. 8, p. 124.)

Here in the case at bar, petitioner National Development Company, a corporation duly organized and existing under the laws of the
Republic of the Philippines, with address and principal office at Calle Pureza, Sta. Mesa, Manila, Philippines unconditionally promised
to pay the Japanese shipbuilders, as obligor in fourteen (14) promissory notes for each vessel, the balance of the contract price of the
twelve (12) ocean-going vessels purchased and acquired by it from the Japanese corporations, including the interest on the principal
sum at the rate of five per cent (5%) per annum. (See Exhs. "D", D-1" to "D-13", pp. 100-113, CTA Records; par. 11, Partial Stipulation
of Facts.) And pursuant to the terms and conditions of these promisory notes, which are duly signed by its Vice Chairman and General
Manager, petitioner remitted to the Japanese shipbuilders in Japan during the years 1960, 1961, and 1962 the sum of $830,613.17,
$1,654,936.52 and $1,541.031.00, respectively, as interest on the unpaid balance of the purchase price of the aforesaid vessels. (pars.
13, 14, & 15, Partial Stipulation of Facts.)

The law is clear. Our plain duty is to apply it as written. The residence of the obligor which paid the interest under consideration,
petitioner herein, is Calle Pureza, Sta. Mesa, Manila, Philippines; and as a corporation duly organized and existing under the laws of
the Philippines, it is a domestic corporation, resident of the Philippines. (Sec. 84(c), National Internal Revenue Code.) The interest
paid by petitioner, which is admittedly a resident of the Philippines, is on the promissory notes issued by it. Clearly, therefore, the
interest remitted to the Japanese shipbuilders in Japan in 1960, 1961 and 1962 on the unpaid balance of the purchase price of the
vessels acquired by petitioner is interest derived from sources within the Philippines subject to income tax under the then Section
9
24(b)(1) of the National Internal Revenue Code.

There is no basis for saying that the interest payments were obligations of the Republic of the Philippines and that the promissory notes of the
NDC were government securities exempt from taxation under Section 29(b)[4] of the Tax Code, reading as follows:

SEC. 29. Gross Income. xxxx xxx xxx xxx

(b) Exclusion from gross income. The following items shall not be included in gross income and shall be exempt from taxation
under this Title:

xxx xxx xxx

 (4) Interest on Government Securities. Interest upon the obligations of the Government of the Republic of the Philippines or any
political subdivision thereof, but in the case of such obligations issued after approval of this Code, only to the extent provided in the
act authorizing the issue thereof. (As amended by Section 6, R.A. No. 82; emphasis supplied)

The law invoked by the petitioner as authorizing the issuance of securities is R.A. No. 1407, which in fact is silent on this matter. C.A. No. 182 as
amended by C.A. No. 311 does carry such authorization but, like R.A. No. 1407, does not exempt from taxes the interests on such securities.

It is also incorrect to suggest that the Republic of the Philippines could not collect taxes on the interest remitted because of the undertaking
signed by the Secretary of Finance in each of the promissory notes that:

Upon authority of the President of the Republic of the Philippines, the undersigned, for value received, hereby absolutely and
unconditionally guarantee (sic), on behalf of the Republic of the Philippines, the due and punctual payment of both principal and
10
interest of the above note.

There is nothing in the above undertaking exempting the interests from taxes. Petitioner has not established a clear waiver therein of the right
11
to tax interests. Tax exemptions cannot be merely implied but must be categorically and unmistakably expressed. Any doubt concerning this
12
question must be resolved in favor of the taxing power.

Nowhere in the said undertaking do we find any inhibition against the collection of the disputed taxes. In fact, such undertaking was made by
the government in consonance with and certainly not against the following provisions of the Tax Code:

Sec. 53(b). Nonresident aliens. All persons, corporations and general co-partnership (companies colectivas), in whatever capacity
acting, including lessees or mortgagors of real or personal capacity, executors, administrators, receivers, conservators, fiduciaries,
employers, and all officers and employees of the Government of the Philippines having control, receipt, custody; disposal or payment
of interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or
determinable annual or categorical gains, profits and income of any nonresident alien individual, not engaged in trade or business
within the Philippines and not having any office or place of business therein, shall (except in the cases provided for in subsection (a)
of this section) deduct and withhold from such annual or periodical gains, profits and income a tax to twenty (now 30%) per centum
thereof: ...

Sec. 54. Payment of corporation income tax at source. In the case of foreign corporations subject to taxation under this Title not
engaged in trade or business within the Philippines and not having any office or place of business therein, there shall be deducted
and withheld at the source in the same manner and upon the same items as is provided in section fifty-three a tax equal to thirty
(now 35%) per centum thereof, and such tax shall be returned and paid in the same manner and subject to the same conditions as
provided in that section:....

Manifestly, the said undertaking of the Republic of the Philippines merely guaranteed the obligations of the NDC but without diminution of its
taxing power under existing laws.

In suggesting that the NDC is merely an administrator of the funds of the Republic of the Philippines, the petitioner closes its eyes to the nature
of this entity as a corporation. As such, it is governed in its proprietary activities not only by its charter but also by the Corporation Code and
other pertinent laws.

The petitioner also forgets that it is not the NDC that is being taxed. The tax was due on the interests earned by the Japanese shipbuilders. It
was the income of these companies and not the Republic of the Philippines that was subject to the tax the NDC did not withhold.

In effect, therefore, the imposition of the deficiency taxes on the NDC is a penalty for its failure to withhold the same from the Japanese
shipbuilders. Such liability is imposed by Section 53(c) of the Tax Code, thus:

Section 53(c). Return and Payment. Every person required to deduct and withhold any tax under this section shall make return
thereof, in duplicate, on or before the fifteenth day of April of each year, and, on or before the time fixed by law for the payment of
the tax, shall pay the amount withheld to the officer of the Government of the Philippines authorized to receive it. Every such person
is made personally liable for such tax, and is indemnified against the claims and demands of any person for the amount of any
payments made in accordance with the provisions of this section. (As amended by Section 9, R.A. No. 2343.)

13
In Philippine Guaranty Co. v. The Commissioner of Internal Revenue and the Court of Tax Appeals, the Court quoted with approval the
following regulation of the BIR on the responsibilities of withholding agents:

In case of doubt, a withholding agent may always protect himself by withholding the tax due, and promptly causing a query to be
addressed to the Commissioner of Internal Revenue for the determination whether or not the income paid to an individual is not
subject to withholding. In case the Commissioner of Internal Revenue decides that the income paid to an individual is not subject to
withholding, the withholding agent may thereupon remit the amount of a tax withheld. (2nd par., Sec. 200, Income Tax Regulations).

"Strict observance of said steps is required of a withholding agent before he could be released from liability," so said Justice Jose P. Bengson,
who wrote the decision. "Generally, the law frowns upon exemption from taxation; hence, an exempting provision should be
14
construed strictissimi juris."

The petitioner was remiss in the discharge of its obligation as the withholding agent of the government an so should be held liable for its
omission.

WHEREFORE, the appealed decision is AFFIRMED, without any pronouncement as to costs. It is so ordered.
G.R. No. 108576 January 20, 1999

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
THE COURT OF APPEALS, COURT OF TAX APPEALS and A. SORIANO CORP., respondents.

MARTINEZ, J.:

1
Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal of the decision of the Court of Appeals (CA) which affirmed the ruling of
2
the Court of Tax Appeals (CTA) that private respondent A. Soriano Corporation's (hereinafter ANSCOR) redemption and exchange of the stocks
of its foreign stockholders cannot be considered as "essentially equivalent to a distribution of taxable dividends" under, Section 83(b) of the
3
1939 Internal Revenue Act.

The undisputed facts are as follows:

Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the United States, formed the corporation "A. Soriano Y Cia", predecessor
of ANSCOR, with a P1,000,000.00 capitalization divided into 10,000 common shares at a par value of P100/share. ANSCOR is wholly owned and
4
controlled by the family of Don Andres, who are all non-resident aliens. In 1937, Don Andres subscribed to 4,963 shares of the 5,000 shares
5
originally issued.

On September 12, 1945, ANSCOR's authorized capital stock was increased to P2,500,000.00 divided into 25,000 common shares with the same
par value of the additional 15,000 shares, only 10,000 was issued which were all subscribed by Don Andres, after the other stockholders waived
6 7
in favor of the former their pre-emptive rights to subscribe to the new issues. This increased his subscription to 14,963 common shares. A
8 9
month later, Don Andres transferred 1,250 shares each to his two sons, Jose and Andres, Jr., as their initial investments in ANSCOR. Both
10
sons are foreigners.

11
By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made between 1949 and December 20, 1963. On
12
December 30, 1964 Don Andres died. As of that date, the records revealed that he has a total shareholdings of 185,154 shares 50,495 of
13
which are original issues and the balance of 134.659 shares as stock dividend declarations. Correspondingly, one-half of that shareholdings or
14 15
92,577 shares were transferred to his wife, Doa Carmen Soriano, as her conjugal share. The other half formed part of his estate.

16 17
A day after Don Andres died, ANSCOR increased its capital stock to P20M and in 1966 further increased it to P30M. In the same year
18
(December 1966), stock dividends worth 46,290 and 46,287 shares were respectively received by the Don Andres estate and Doa Carmen
19 20
from ANSCOR. Hence, increasing their accumulated shareholdings to 138,867 and 138,864 common shares each.

On December 28, 1967, Doa Carmen requested a ruling from the United States Internal Revenue Service (IRS), inquiring if an exchange of
21 22
common with preferred shares may be considered as a tax avoidance scheme under Section 367 of the 1954 U.S. Revenue Act. By January
23
2, 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000 preferred shares.

In a letter-reply dated February 1968, the IRS opined that the exchange is only a recapitalization scheme and not tax
24 25
avoidance. Consequently, on March 31, 1968 Doa Carmen exchanged her whole 138,864 common shares for 138,860 of the newly
reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares, for the remaining 11,140 preferred
26
shares, thus reducing its (the estate) common shares to 127,727.

On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don Andres' estate. By November
27
1968, the Board further increased ANSCOR's capital stock to P75M divided into 150,000 preferred shares and 600,000 common shares. About
28
a year later, ANSCOR again redeemed 80,000 common shares from the Don Andres' estate, further reducing the latter's common
shareholdings to 19,727. As stated in the Board Resolutions, ANSCOR's business purpose for both redemptions of stocks is to partially retire
29
said stocks as treasury shares in order to reduce the company's foreign exchange remittances in case cash dividends are declared.

In 1973, after examining ANSCOR's books of account and records, Revenue examiners issued a report proposing that ANSCOR be assessed for
30
deficiency withholding tax-at-source, pursuant to Sections 53 and 54 of the 1939 Revenue Code, for the year 1968 and the second quarter of
31
1969 based on the transactions of exchange 31 and redemption of stocks. The Bureau of Internal Revenue (BIR) made the corresponding
assessments despite the claim of ANSCOR that it availed of the tax amnesty under Presidential Decree
32 33
(P.D.) 23 which were amended by P.D.'s 67 and 157. However, petitioner ruled that the invoked decrees do not cover Sections 53 and 54 in
34
relation to Article 83(b) of the 1939 Revenue Act under which ANSCOR was assessed. ANSCOR's subsequent protest on the assessments was
35
denied in 1983 by petitioner.
Subsequently, ANSCOR filed a petition for review with the CTA assailing the tax assessments on the redemptions and exchange of stocks. In its
decision, the Tax Court reversed petitioner's ruling, after finding sufficient evidence to overcome the prima facie correctness of the questioned
36 37
assessments. In a petition for review the CA as mentioned, affirmed the ruling of the CTA. Hence, this petition.

38
The bone of contention is the interpretation and application of Section 83(b) of the 1939 Revenue Act which provides:

Sec. 83. Distribution of dividends or assets by corporations.

(b) Stock dividends A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.
However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the
distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable
dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the
extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen.
(Emphasis supplied)

Specifically, the issue is whether ANSCOR's redemption of stocks from its stockholder as well as the exchange of common with
preferred shares can be considered as "essentially equivalent to the distribution of taxable dividend" making the proceeds thereof
taxable under the provisions of the above-quoted law.

Petitioner contends that the exchange transaction a tantamount to "cancellation" under Section 83(b) making the proceeds thereof taxable. It
also argues that the Section applies to stock dividends which is the bulk of stocks that ANSCOR redeemed. Further, petitioner claims that under
the "net effect test," the estate of Don Andres gained from the redemption. Accordingly, it was the duty of ANSCOR to withhold the tax-at-
39
source arising from the two transactions, pursuant to Section 53 and 54 of the 1939 Revenue Act.

ANSCOR, however, avers that it has no duty to withhold any tax either from the Don Andres estate or from Doa Carmen based on the two
transactions, because the same were done for legitimate business purposes which are (a) to reduce its foreign exchange remittances in the
40
event the company would declare cash dividends, and to (b) subsequently "filipinized" ownership of ANSCOR, as allegedly, envisioned by Don
41
Andres. It likewise invoked the amnesty provisions of P.D. 67.

42
We must emphasize that the application of Sec. 83(b) depends on the special factual circumstances of each case. The findings of facts of a
43
special court (CTA) exercising particular expertise on the subject of tax, generally binds this Court, considering that it is substantially similar to
44
the findings of the CA which is the final arbiter of questions of facts. The issue in this case does not only deal with facts but whether the law
applies to a particular set of facts. Moreover, this Court is not necessarily bound by the lower courts' conclusions of law drawn from such
45
facts.

AMNESTY:

46
We will deal first with the issue of tax amnesty. Section 1 of P.D. 67 provides:

1. In all cases of voluntary disclosures of previously untaxed income and/or wealth such as earnings, receipts, gifts, bequests
or any other acquisitions from any source whatsoever which are taxable under the National Internal Revenue Code, as
amended, realized here or abroad by any taxpayer, natural or judicial; the collection of all internal revenue taxes including
the increments or penalties or account of non-payment as well as all civil, criminal or administrative liabilities arising from
or incident to such disclosures under the National Internal Revenue Code, the Revised Penal Code, the Anti-Graft and
Corrupt Practices Act, the Revised Administrative Code, the Civil Service laws and regulations, laws and regulations on
Immigration and Deportation, or any other applicable law or proclamation, are hereby condoned and, in lieu thereof, a tax
of ten (10%) per centum on such previously untaxed income or wealth, is hereby imposed, subject to the following
conditions: (conditions omitted) [Emphasis supplied].

The decree condones "the collection of all internal revenue taxes including the increments or penalties or account of non-payment as
well as all civil, criminal or administrative liable arising from or incident to" (voluntary) disclosures under the NIRC of previously
untaxed income and/or wealth "realized here or abroad by any taxpayer, natural or juridical."

May the withholding agent, in such capacity, be deemed a taxpayer for it to avail of the amnesty? An income taxpayer covers all persons who
47
derive taxable income. ANSCOR was assessed by petitioner for deficiency withholding tax under Section 53 and 54 of the 1939 Code. As such,
it is being held liable in its capacity as a withholding agent and not its personality as a taxpayer.

In the operation of the withholding tax system, the withholding agent is the payor, a separate entity acting no more than an agent of the
48 49
government for the collection of the tax in order to ensure its payments; the payer is the taxpayer he is the person subject to tax impose
50 51
by law; and the payee is the taxing authority. In other words, the withholding agent is merely a tax collector, not a taxpayer. Under the
withholding system, however, the agent-payor becomes a payee by fiction of law. His (agent) liability is direct and independent from the
52
taxpayer, because the income tax is still impose on and due from the latter. The agent is not liable for the tax as no wealth flowed into him
53
he earned no income. The Tax Code only makes the agent personally liable for the tax arising from the breach of its legal duty to withhold as
distinguish from its duty to pay tax since:

the government's cause of action against the withholding is not for the collection of income tax, but for the enforcement of
the withholding provision of Section 53 of the Tax Code, compliance with which is imposed on the withholding agent and
54
not upon the taxpayer.

Not being a taxpayer, a withholding agent, like ANSCOR in this transaction is not protected by the amnesty under the decree.
 55
Codal provisions on withholding tax are mandatory and must be complied with by the withholding agent. The taxpayer should not answer for
the non-performance by the withholding agent of its legal duty to withhold unless there is collusion or bad faith. The former could not be
deemed to have evaded the tax had the withholding agent performed its duty. This could be the situation for which the amnesty decree was
56
intended. Thus, to curtail tax evasion and give tax evaders a chance to reform, it was deemed administratively feasible to grant tax amnesty
in certain instances. In addition, a "tax amnesty, much like a tax exemption, is never favored nor presumed in law and if granted by a statute,
the term of the amnesty like that of a tax exemption must be construed strictly against the taxpayer and liberally in favor of the taxing
57 58
authority. The rule on strictissimi juris equally applies. So that, any doubt in the application of an amnesty law/decree should be resolved in
favor of the taxing authority.

Furthermore, ANSCOR's claim of amnesty cannot prosper. The implementing rules of P.D. 370 which expanded amnesty on
previously untaxed income under P.D. 23 is very explicit, to wit:

Sec. 4. Cases not covered by amnesty. The following cases are not covered by the amnesty subject of these regulations:

xxx xxx xxx

(2) Tax liabilities with or without assessments, on withholding tax at source provided under Section 53 and 54 of the
59
National Internal Revenue Code, as amended;

ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax Code. Thus, by specific provision of law, it is not covered by the
amnesty.

TAX ON STOCK DIVIDENDS

General Rule

60
Sec. 83(b) of the 1939 NIRC was taken from the Section 115(g)(1) of the U.S. Revenue Code of 1928. It laid down the general rule known as
61 62
the proportionate test wherein stock dividends once issued form part of the capital and, thus, subject to income tax. Specifically, the
general rule states that:

A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.

Having been derived from a foreign law, resort to the jurisprudence of its origin may shed light. Under the US Revenue Code, this provision
originally referred to "stock dividends" only, without any exception. Stock dividends, strictly speaking, represent capital and do not constitute
income to its
63 64
recipient. So that the mere issuance thereof is not yet subject to income tax as they are nothing but an "enrichment through increase in
value of capital
65
investment." As capital, the stock dividends postpone the realization of profits because the "fund represented by the new stock has been
66
transferred from surplus to capital and no longer available for actual distribution." Income in tax law is "an amount of money coming to a
67 68
person within a specified time, whether as payment for services, interest, or profit from investment." It means cash or its equivalent. It is
69 70
gain derived and severed from capital, from labor or from both combined so that to tax a stock dividend would be to tax a capital
71
increase rather than the income. In a loose sense, stock dividends issued by the corporation, are considered unrealized gain, and cannot be
subjected to income tax until that gain has been realized. Before the realization, stock dividends are nothing but a representation of an interest
72
in the corporate properties. As capital, it is not yet subject to income tax. It should be noted that capital and income are different. Capital is
73
wealth or fund; whereas income is profit or gain or the flow of wealth. The determining factor for the imposition of income tax is whether any
74
gain or profit was derived from a transaction.

The Exception

However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make
the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable
dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the
extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen.
(Emphasis supplied).

75
In a response to the ruling of the American Supreme Court in the case of Eisner v. Macomber (that pro rata stock dividends are not taxable
income), the exempting clause above quoted was added because provision corporation found a loophole in the original provision. They
resorted to devious means to circumvent the law and evade the tax. Corporate earnings would be distributed under the guise of its initial
capitalization by declaring the stock dividends previously issued and later redeem said dividends by paying cash to the stockholder. This process
of issuance-redemption amounts to a distribution of taxable cash dividends which was lust delayed so as to escape the tax. It becomes a
convenient technical strategy to avoid the effects of taxation.

Thus, to plug the loophole the exempting clause was added. It provides that the redemption or cancellation of stock dividends, depending
on the "time" and "manner" it was made, is essentially equivalent to a distribution of taxable dividends," making the proceeds thereof "taxable
income" "to the extent it represents profits". The exception was designed to prevent the issuance and cancellation or redemption of stock
dividends, which is fundamentally not taxable, from being made use of as a device for the actual distribution of cash dividends, which is
76
taxable. Thus,

the provision had the obvious purpose of preventing a corporation from avoiding dividend tax treatment by distributing
earnings to its shareholders in two transactions a pro rata stock dividend followed by a pro rata redemption that
77
would have the same economic consequences as a simple dividend.
 Although redemption and cancellation are generally considered capital transactions, as such. they are not subject to tax. However, it
78
does not necessarily mean that a shareholder may not realize a taxable gain from such transactions. Simply put, depending on the
circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid
becomes the absolute property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and can exercise the
79 80
freedom of choice. Having realized gain from that redemption, the income earner cannot escape income tax.

As qualified by the phrase "such time and in such manner," the exception was not intended to characterize as taxable dividend every
81
distribution of earnings arising from the redemption of stock dividend. So that, whether the amount distributed in the redemption should be
82
treated as the equivalent of a "taxable dividend" is a question of fact, which is determinable on "the basis of the particular facts of the
83
transaction in question. No decisive test can be used to determine the application of the exemption under Section 83(b). The use of the
words "such manner" and "essentially equivalent" negative any idea that a weighted formula can resolve a crucial issue Should the
84
distribution be treated as taxable dividend. On this aspect, American courts developed certain recognized criteria, which includes the
85
following:

1) the presence or absence of real business purpose,

2) the amount of earnings and profits available for the declaration of a regular dividends and the
corporation's past record with respect to the declaration of dividends,

3) the effect of the distribution, as compared with the declaration of regular dividend,

86
4) the lapse of time between issuance and redemption,

87
5) the presence of a substantial surplus and a generous supply of cash which invites suspicion as does
88
a meager policy in relation both to current earnings and accumulated surplus,

REDEMPTION AND CANCELLATION

For the exempting clause of Section, 83(b) to apply, it is indispensable that: (a) there is redemption or cancellation; (b) the
transaction involves stock dividends and (c) the "time and manner" of the transaction makes it "essentially equivalent to a
distribution of taxable dividends." Of these, the most important is the third.

89
Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock in exchange for property, whether or not the
90
acquired stock is cancelled, retired or held in the treasury. Essentially, the corporation gets back some of its stock, distributes cash or
property to the shareholder in payment for the stock, and continues in business as before. The redemption of stock dividends previously issued
is used as a veil for the constructive distribution of cash dividends. In the instant case, there is no dispute that ANSCOR redeemed shares of
stocks from a stockholder (Don Andres) twice (28,000 and 80,000 common shares). But where did the shares redeemed come from? If its
source is the original capital subscriptions upon establishment of the corporation or from initial capital investment in an existing enterprise, its
redemption to the concurrent value of acquisition may not invite the application of Sec. 83(b) under the 1939 Tax Code, as it is not income but
a mere return of capital. On the contrary, if the redeemed shares are from stock dividend declarations other than as initial capital investment,
the proceeds of the redemption is additional wealth, for it is not merely a return of capital but a gain thereon.

It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable dividends. Here, it is undisputed that at the
91
time of the last redemption, the original common shares owned by the estate were only 25,247.5 This means that from the total of 108,000
shares redeemed from the estate, the balance of 82,752.5 (108,000 less 25,247.5) must have come from stock dividends. Besides, in the
absence of evidence to the contrary, the Tax Code presumes that every distribution of corporate property, in whole or in part, is made out of
92
corporate profits such as stock dividends. The capital cannot be distributed in the form of redemption of stock dividends without violating the
trust fund doctrine wherein the capital stock, property and other assets of the corporation are regarded as equity in trust for the payment of
93 94 95
the corporate creditors. Once capital, it is always capital. That doctrine was intended for the protection of corporate creditors.

With respect to the third requisite, ANSCOR redeemed stock dividends issued just 2 to 3 years earlier. The time alone that lapsed from the
issuance to the redemption is not a sufficient indicator to determine taxability. It is a must to consider the factual circumstances as to the
manner of both the issuance and the redemption. The "time" element is a factor to show a device to evade tax and the scheme of cancelling or
96
redeeming the same shares is a method usually adopted to accomplish the end sought. Was this transaction used as a "continuing plan,"
"device" or "artifice" to evade payment of tax? It is necessary to determine the "net effect" of the transaction between the shareholder-income
97
taxpayer and the acquiring (redeeming) corporation. The "net effect" test is not evidence or testimony to be considered; it is rather an
98
inference to be drawn or a conclusion to be reached. It is also important to know whether the issuance of stock dividends was dictated by
99
legitimate business reasons, the presence of which might negate a tax evasion plan.

The issuance of stock dividends and its subsequent redemption must be separate, distinct, and not related, for the redemption to be
100 101
considered a legitimate tax scheme. Redemption cannot be used as a cloak to distribute corporate earnings. Otherwise, the apparent
intention to avoid tax becomes doubtful as the intention to evade becomes manifest. It has been ruled that:

[A]n operation with no business or corporate purpose is a mere devise which put on the form of a corporate
reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the
consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of
102
corporate shares to a stockholder.

Depending on each case, the exempting provision of Sec. 83(b) of the 1939 Code may not be applicable if the redeemed shares were issued
103
with bona fide business purpose, which is judged after each and every step of the transaction have been considered and the whole
transaction does not amount to a tax evasion scheme.
ANSCOR invoked two reasons to justify the redemptions (1) the alleged "filipinization" program and (2) the reduction of foreign exchange
remittances in case cash dividends are declared. The Court is not concerned with the wisdom of these purposes but on their relevance to the
whole transaction which can be inferred from the outcome thereof. Again, it is the "net effect rather than the motives and plans of the
104 105
taxpayer or his corporation" that is the fundamental guide in administering Sec. 83(b). This tax provision is aimed at the result. It also
applies even if at the time of the issuance of the stock dividend, there was no intention to redeem it as a means of distributing profit or
106
avoiding tax on dividends. The existence of legitimate business purposes in support of the redemption of stock dividends is immaterial in
107
income taxation. It has no relevance in determining "dividend equivalence". Such purposes may be material only upon the issuance of the
stock dividends. The test of taxability under the exempting clause, when it provides "such time and manner" as would make the redemption
"essentially equivalent to the distribution of a taxable dividend", is whether the redemption resulted into a flow of wealth. If no wealth is
realized from the redemption, there may not be a dividend equivalence treatment. In the metaphor of Eisner v. Macomber, income is not
deemed "realize" until the fruit has fallen or been plucked from the tree.

The three elements in the imposition of income tax are: (1) there must be gain or and profit, (2) that the gain or profit is realized or received,
108
actually or constructively, and (3) it is not exempted by law or treaty from income tax. Any business purpose as to why or how the income
was earned by the taxpayer is not a requirement. Income tax is assessed on income received from any property, activity or service that
produces the income because the Tax Code stands as an indifferent neutral party on the matter of where income comes
109
from.

As stated above, the test of taxability under the exempting clause of Section 83(b) is, whether income was realized through the redemption of
stock dividends. The redemption converts into money the stock dividends which become a realized profit or gain and consequently, the
110
stockholder's separate property. Profits derived from the capital invested cannot escape income tax. As realized income, the proceeds of the
redeemed stock dividends can be reached by income taxation regardless of the existence of any business purpose for the redemption.
Otherwise, to rule that the said proceeds are exempt from income tax when the redemption is supported by legitimate business reasons would
defeat the very purpose of imposing tax on income. Such argument would open the door for income earners not to pay tax so long as the
person from whom the income was derived has legitimate business reasons. In other words, the payment of tax under the exempting clause of
Section 83(b) would be made to depend not on the income of the taxpayer, but on the business purposes of a third party (the corporation
herein) from whom the income was earned. This is absurd, illogical and impractical considering that the Bureau of Internal Revenue (BIR) would
be pestered with instances in determining the legitimacy of business reasons that every income earner may interposed. It is not
administratively feasible and cannot therefore be allowed.

The ruling in the American cases cited and relied upon by ANSCOR that "the redeemed shares are the equivalent of dividend only if the shares
111 112
were not issued for genuine business purposes", or the "redeemed shares have been issued by a corporation bona fide" bears no
relevance in determining the non-taxability of the proceeds of redemption ANSCOR, relying heavily and applying said cases, argued that so long
113 114
as the redemption is supported by valid corporate purposes the proceeds are not subject to tax. The adoption by the courts below of
such argument is misleading if not misplaced. A review of the cited American cases shows that the presence or absence of "genuine business
purposes" may be material with respect to the issuance or declaration of stock dividends but not on its subsequent redemption. The issuance
and the redemption of stocks are two different transactions. Although the existence of legitimate corporate purposes may justify a
115
corporation's acquisition of its own shares under Section 41 of the Corporation Code, such purposes cannot excuse the stockholder from the
effects of taxation arising from the redemption. If the issuance of stock dividends is part of a tax evasion plan and thus, without legitimate
business reasons, the redemption becomes suspicious which exempting clause. The substance of the whole transaction, not its form, usually
116
controls the tax consequences.

The two purposes invoked by ANSCOR, under the facts of this case are no excuse for its tax liability. First, the alleged "filipinization" plan cannot
be considered legitimate as it was not implemented until the BIR started making assessments on the proceeds of the redemption. Such
corporate plan was not stated in nor supported by any Board Resolution but a mere afterthought interposed by the counsel of ANSCOR. Being a
117
separate entity, the corporation can act only through its Board of Directors. The Board Resolutions authorizing the redemptions state only
one purpose reduction of foreign exchange remittances in case cash dividends are declared. Not even this purpose can be given credence.
Records show that despite the existence of enormous corporate profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR
started making assessments in the early 1970's. Although a corporation under certain exceptions, has the prerogative when to issue dividends,
yet when no cash dividends was issued for about three decades, this circumstance negates the legitimacy of ANSCOR's alleged purposes.
Moreover, to issue stock dividends is to increase the shareholdings of ANSCOR's foreign stockholders contrary to its "filipinization" plan. This
would also increase rather than reduce their need for foreign exchange remittances in case of cash dividend declaration, considering that
ANSCOR is a family corporation where the majority shares at the time of redemptions were held by Don Andres' foreign heirs.

Secondly, assuming arguendo, that those business purposes are legitimate, the same cannot be a valid excuse for the imposition of tax.
Otherwise, the taxpayer's liability to pay income tax would be made to depend upon a third person who did not earn the income being taxed.
Furthermore, even if the said purposes support the redemption and justify the issuance of stock dividends, the same has no bearing
whatsoever on the imposition of the tax herein assessed because the proceeds of the redemption are deemed taxable dividends since it was
shown that income was generated therefrom.

Thirdly, ANSCOR argued that to treat as "taxable dividend" the proceeds of the redeemed stock dividends would be to impose on such stock an
118
undisclosed lien and would be extremely unfair to intervening purchase, i.e. those who buys the stock dividends after their issuance. Such
argument, however, bears no relevance in this case as no intervening buyer is involved. And even if there is an intervening buyer, it is necessary
to look into the factual milieu of the case if income was realized from the transaction. Again, we reiterate that the dividend equivalence test
119
depends on such "time and manner" of the transaction and its net effect. The undisclosed lien may be unfair to a subsequent stock buyer
who has no capital interest in the company. But the unfairness may not be true to an original subscriber like Don Andres, who holds stock
dividends as gains from his investments. The subsequent buyer who buys stock dividends is investing capital. It just so happen that what he
bought is stock dividends. The effect of its (stock dividends) redemption from that subsequent buyer is merely to return his capital subscription,
which is income if redeemed from the original subscriber.

After considering the manner and the circumstances by which the issuance and redemption of stock dividends were made, there is no other
conclusion but that the proceeds thereof are essentially considered equivalent to a distribution of taxable dividends. As "taxable dividend"
120
under Section 83(b), it is part of the "entire income" subject to tax under Section 22 in relation to Section 21 of the 1939 Code. Moreover,
under Section 29(a) of said Code, dividends are included in "gross income". As income, it is subject to income tax which is required to be
withheld at source. The 1997 Tax Code may have altered the situation but it does not change this disposition.
 121
EXCHANGE OF COMMON WITH PREFERRED SHARES

122 123
Exchange is an act of taking or giving one thing for another involving reciprocal transfer and is generally considered as a taxable
transaction. The exchange of common stocks with preferred stocks, or preferred for common or a combination of either for both, may not
produce a recognized gain or loss, so long as the provisions of Section 83(b) is not applicable. This is true in a trade between two (2) persons as
well as a trade between a stockholder and a corporation. In general, this trade must be parts of merger, transfer to controlled corporation,
corporate acquisitions or corporate reorganizations. No taxable gain or loss may be recognized on exchange of property, stock or securities
124
related to reorganizations.

Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares into common and preferred, and that parts of the
common shares of the Don Andres estate and all of Doa Carmen's shares were exchanged for the whole 150.000 preferred shares. Thereafter,
both the Don Andres estate and Doa Carmen remained as corporate subscribers except that their subscriptions now include preferred shares.
There was no change in their proportional interest after the exchange. There was no cash flow. Both stocks had the same par value. Under the
facts herein, any difference in their market value would be immaterial at the time of exchange because no income is yet realized it was a
mere corporate paper transaction. It would have been different, if the exchange transaction resulted into a flow of wealth, in which case
125
income tax may be imposed.

Reclassification of shares does not always bring any substantial alteration in the subscriber's proportional interest. But the exchange is different
there would be a shifting of the balance of stock features, like priority in dividend declarations or absence of voting rights. Yet neither the
reclassification nor exchange per se, yields realize income for tax purposes. A common stock represents the residual ownership interest in the
corporation. It is a basic class of stock ordinarily and usually issued without extraordinary rights or privileges and entitles the shareholder to
126 127
a pro rata division of profits. Preferred stocks are those which entitle the shareholder to some priority on dividends and asset distribution.

Both shares are part of the corporation's capital stock. Both stockholders are no different from ordinary investors who take on the same
investment risks. Preferred and common shareholders participate in the same venture, willing to share in the profits and losses of the
128
enterprise. Moreover, under the doctrine of equality of shares all stocks issued by the corporation are presumed equal with the same
129
privileges and liabilities, provided that the Articles of Incorporation is silent on such differences.

In this case, the exchange of shares, without more, produces no realized income to the subscriber. There is only a modification of the
subscriber's rights and privileges which is not a flow of wealth for tax purposes. The issue of taxable dividend may arise only once a
130
subscriber disposes of his entire interest and not when there is still maintenance of proprietary interest.

WHEREFORE, premises considered, the decision of the Court of Appeals is MODIFIED in that ANSCOR's redemption of 82,752.5 stock dividends
is herein considered as essentially equivalent to a distribution of taxable dividends for which it is LIABLE for the withholding tax-at-source. The
decision is AFFIRMED in all other respects.

SO ORDERED.

G.R. No. L-66838 December 2, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
PROCTER & GAMBLE PHILIPPINE MANUFACTURING CORPORATION and THE COURT OF TAX APPEALS,respondents.

T.A. Tejada & C.N. Lim for private respondent.

RESOLUTION

FELICIANO, J.:

For the taxable year 1974 ending on 30 June 1974, and the taxable year 1975 ending 30 June 1975, private respondent Procter and Gamble
Philippine Manufacturing Corporation ("P&G-Phil.") declared dividends payable to its parent company and sole stockholder, Procter and
Gamble Co., Inc. (USA) ("P&G-USA"), amounting to P24,164,946.30, from which dividends the amount of P8,457,731.21 representing the thirty-
five percent (35%) withholding tax at source was deducted.

On 5 January 1977, private respondent P&G-Phil. filed with petitioner Commissioner of Internal Revenue a claim for refund or tax credit in the
1
amount of P4,832,989.26 claiming, among other things, that pursuant to Section 24 (b) (1) of the National Internal Revenue Code ("NITC"), as
amended by Presidential Decree No. 369, the applicable rate of withholding tax on the dividends remitted was only fifteen percent (15%) (and
not thirty-five percent [35%]) of the dividends.
There being no responsive action on the part of the Commissioner, P&G-Phil., on 13 July 1977, filed a petition for review with public
respondent Court of Tax Appeals ("CTA") docketed as CTA Case No. 2883. On 31 January 1984, the CTA rendered a decision ordering petitioner
Commissioner to refund or grant the tax credit in the amount of P4,832,989.00.

On appeal by the Commissioner, the Court through its Second Division reversed the decision of the CTA and held that:

(a) P&G-USA, and not private respondent P&G-Phil., was the proper party to claim the refund or tax credit here involved;

(b) there is nothing in Section 902 or other provisions of the US Tax Code that allows a credit against the US tax due from P&G-USA of
taxes deemed to have been paid in the Philippines equivalent to twenty percent (20%) which represents the difference between the
regular tax of thirty-five percent (35%) on corporations and the tax of fifteen percent (15%) on dividends; and

(c) private respondent P&G-Phil. failed to meet certain conditions necessary in order that "the dividends received by its non-resident
parent company in the US (P&G-USA) may be subject to the preferential tax rate of 15% instead of 35%."

These holdings were questioned in P&G-Phil.'s Motion for Re-consideration and we will deal with them seriatim in this Resolution resolving that
Motion.

1. There are certain preliminary aspects of the question of the capacity of P&G-Phil. to bring the present claim for refund or tax credit, which
need to be examined. This question was raised for the first time on appeal, i.e., in the proceedings before this Court on the Petition for Review
filed by the Commissioner of Internal Revenue. The question was not raised by the Commissioner on the administrative level, and neither was it
raised by him before the CTA.

We believe that the Bureau of Internal Revenue ("BIR") should not be allowed to defeat an otherwise valid claim for refund by raising this
question of alleged incapacity for the first time on appeal before this Court. This is clearly a matter of procedure. Petitioner does not pretend
that P&G-Phil., should it succeed in the claim for refund, is likely to run away, as it were, with the refund instead of transmitting such refund or
tax credit to its parent and sole stockholder. It is commonplace that in the absence of explicit statutory provisions to the contrary, the
government must follow the same rules of procedure which bind private parties. It is, for instance, clear that the government is held to
compliance with the provisions of Circular No. 1-88 of this Court in exactly the same way that private litigants are held to such compliance, save
only in respect of the matter of filing fees from which the Republic of the Philippines is exempt by the Rules of Court.

More importantly, there arises here a question of fairness should the BIR, unlike any other litigant, be allowed to raise for the first time on
appeal questions which had not been litigated either in the lower court or on the administrative level. For, if petitioner had at the earliest
possible opportunity, i.e., at the administrative level, demanded that P&G-Phil. produce an express authorization from its parent corporation to
bring the claim for refund, then P&G-Phil. would have been able forthwith to secure and produce such authorization before filing the action in
the instant case. The action here was commenced just before expiration of the two (2)-year prescriptive period.

2. The question of the capacity of P&G-Phil. to bring the claim for refund has substantive dimensions as well which, as will be seen below, also
ultimately relate to fairness.

Under Section 306 of the NIRC, a claim for refund or tax credit filed with the Commissioner of Internal Revenue is essential for maintenance of
a suit for recovery of taxes allegedly erroneously or illegally assessed or collected:

Sec. 306. Recovery of tax erroneously or illegally collected. No suit or proceeding shall be maintained in any court for the recovery
of any national internal revenue tax hereafter alleged to have been erroneously or illegally assessed or collected, or of any penalty
claimed to have been collected without authority, or of any sum alleged to have been excessive or in any manner wrongfully
collected, until a claim for refund or credit has been duly filed with the Commissioner of Internal Revenue; but such suit or proceeding
may be maintained, whether or not such tax, penalty, or sum has been paid under protest or duress. In any case, no such suit or
proceeding shall be begun after the expiration of two years from the date of payment of the tax or penalty regardless of any
supervening cause that may arise after payment: . . . (Emphasis supplied)

Section 309 (3) of the NIRC, in turn, provides:

Sec. 309. Authority of Commissioner to Take Compromises and to Refund Taxes.The Commissioner may:

xxx xxx xxx

(3) credit or refund taxes erroneously or illegally received, . . . No credit or refund of taxes or penalties shall be allowed unless the taxpayer files
in writing with the Commissioner a claim for credit or refund within two (2) years after the payment of the tax or penalty. (As amended by P.D.
No. 69) (Emphasis supplied)

Since the claim for refund was filed by P&G-Phil., the question which arises is: is P&G-Phil. a "taxpayer" under Section 309 (3) of the NIRC? The
2
term "taxpayer" is defined in our NIRC as referring to "any person subject to taximposed by the Title [on Tax on Income]." It thus becomes
important to note that under Section 53 (c) of the NIRC, the withholding agent who is "required to deduct and withhold any tax" is made
" personally liable for such tax" and indeed is indemnified against any claims and demands which the stockholder might wish to make in
questioning the amount of payments effected by the withholding agent in accordance with the provisions of the NIRC. The withholding agent,
3
P&G-Phil., is directly and independently liable for the correct amount of the tax that should be withheld from the dividend remittances. The
withholding agent is, moreover, subject to and liable for deficiency assessments, surcharges and penalties should the amount of the tax
withheld be finally found to be less than the amount that should have been withheld under law.
 4
A "person liable for tax" has been held to be a "person subject to tax" and properly considered a "taxpayer." The terms liable for tax" and
"subject to tax" both connote legal obligation or duty to pay a tax. It is very difficult, indeed conceptually impossible, to consider a person who
is statutorily made "liable for tax" as not "subject to tax." By any reasonable standard, such a person should be regarded as a party in interest,
or as a person having sufficient legal interest, to bring a suit for refund of taxes he believes were illegally collected from him.

5
In Philippine Guaranty Company, Inc. v. Commissioner of Internal Revenue, this Court pointed out that a withholding agent is in fact the agent
both of the government and of the taxpayer, and that the withholding agent is not an ordinary government agent:

The law sets no condition for the personal liability of the withholding agent to attach. The reason is to compel the withholding agent
to withhold the tax under all circumstances. In effect, the responsibility for the collection of the tax as well as the payment thereof is
concentrated upon the person over whom the Government has jurisdiction. Thus, the withholding agent is constituted the agent of
both the Government and the taxpayer. With respect to the collection and/or withholding of the tax, he is the Government's agent. In
regard to the filing of the necessary income tax return and the payment of the tax to the Government, he is the agent of the taxpayer.
The withholding agent, therefore, is no ordinary government agent especially because under Section 53 (c) he is held personally liable
6 (Emphasis supplied)
for the tax he is duty bound to withhold; whereas the Commissioner and his deputies are not made liable by law.

If, as pointed out in Philippine Guaranty, the withholding agent is also an agent of the beneficial owner of the dividends with respect to the filing of the necessary income tax return and with respect to actual
payment of the tax to the government, such authority may reasonably be held to include the authority to file a claim for refund and to bring an action for recovery of such claim. This implied authority is especially
warranted where, is in the instant case, the withholding agent is the wholly owned subsidiary of the parent-stockholder and therefore, at all times, under the effective control of such parent-stockholder. In the
circumstances of this case, it seems particularly unreal to deny the implied authority of P&G-Phil. to claim a refund and to commence an action for such refund.

We believe that, even now, there is nothing to preclude the BIR from requiring P&G-Phil. to show some written or telexed confirmation by P&G-USA of the subsidiary's authority to claim the refund or tax credit and
to remit the proceeds of the refund., or to apply the tax credit to some Philippine tax obligation of, P&G-USA, before actual payment of the refund or issuance of a tax credit certificate. What appears to be vitiated by
basic unfairness is petitioner's position that, although P&G-Phil. is directly and personally liable to the Government for the taxes and any deficiency assessments to be collected, the Government is not legally liable for
a refund simply because it did not demand a written confirmation of P&G-Phil.'s implied authority from the very beginning. A sovereign government should act honorably and fairly at all times, even vis-a-
vis taxpayers.

We believe and so hold that, under the circumstances of this case, P&G-Phil. is properly regarded as a "taxpayer" within the meaning of Section 309, NIRC, and as impliedly authorized to file the claim for refund and
the suit to recover such claim.

II

1. We turn to the principal substantive question before us: the applicability to the dividend remittances by P&G-Phil. to P&G-USA of the fifteen percent (15%) tax rate provided for in the following portion of Section
24 (b) (1) of the NIRC:

(b) Tax on foreign corporations.

(1) Non-resident corporation. A foreign corporation not engaged in trade and business in the Philippines, . . ., shall pay a tax equal to 35% of the gross income receipt during its taxable year from all
sources within the Philippines, as . . . dividends . . . Provided, still further, that on dividends received from a domestic corporation liable to tax under this Chapter, the tax shall be 15% of the dividends,
which shall be collected and paid as provided in Section 53 (d) of this Code, subject to the condition that the country in which the non-resident foreign corporation, is domiciled shall allow a credit
against the tax due from the non-resident foreign corporation, taxes deemed to have been paid in the Philippines equivalent to 20% which represents the difference between the regular tax (35%) on
corporations and the tax (15%) on dividends as provided in this Section . . .

The ordinary thirty-five percent (35%) tax rate applicable to dividend remittances to non-resident corporate stockholders of a Philippine corporation, goes down to fifteen percent (15%) if the country of domicile of
the foreign stockholder corporation "shall allow" such foreign corporation a tax credit for "taxes deemed paid in the Philippines," applicable against the tax payable to the domiciliary country by the foreign
stockholder corporation. In other words, in the instant case, the reduced fifteen percent (15%) dividend tax rate is applicable if the USA "shall allow" to P&G-USA a tax credit for "taxes deemed paid in the Philippines"
applicable against the US taxes of P&G-USA. The NIRC specifies that such tax credit for "taxes deemed paid in the Philippines" must, as a minimum, reach an amount equivalent to twenty (20) percentage points which
represents the difference between the regular thirty-five percent (35%) dividend tax rate and the preferred fifteen percent (15%) dividend tax rate.

It is important to note that Section 24 (b) (1), NIRC, does not require that the US must give a "deemed paid" tax credit for the dividend tax (20 percentage points) waived by the Philippines in making applicable the
preferred divided tax rate of fifteen percent (15%). In other words, our NIRC does not require that the US tax law deem the parent-corporation to have paid the twenty (20) percentage points of dividend tax waived by
the Philippines. The NIRC only requires that the US "shall allow" P&G-USA a "deemed paid" tax credit in an amount equivalent to the twenty (20) percentage points waived by the Philippines.

2. The question arises: Did the US law comply with the above requirement? The relevant provisions of the US Intemal Revenue Code ("Tax Code") are the following:

Sec. 901 Taxes of foreign countries and possessions of United States.

(a) Allowance of credit. If the taxpayer chooses to have the benefits of this subpart, the tax imposed by this chapter shall, subject to the applicable limitation of section 904, be credited with the
amounts provided in the applicable paragraph of subsection (b) plus, in the case of a corporation, the taxes deemed to have been paid under sections 902 and 960. Such choice for any taxable year may
be made or changed at any time before the expiration of the period prescribed for making a claim for credit or refund of the tax imposed by this chapter for such taxable year. The credit shall not be
allowed against the tax imposed by section 531 (relating to the tax on accumulated earnings), against the additional tax imposed for the taxable year under section 1333 (relating to war loss recoveries)
or under section 1351 (relating to recoveries of foreign expropriation losses), or against the personal holding company tax imposed by section 541.

(b) Amount allowed. Subject to the applicable limitation of section 904, the following amounts shall be allowed as the credit under subsection (a):

(a) Citizens and domestic corporations. In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war profits, and excess profits taxes paid
or accrued during the taxable year to any foreign country or to any possession of the United States; and
 xxx xxx xxx

Sec. 902. Credit for corporate stockholders in foreign corporation.

(A) Treatment of Taxes Paid by Foreign Corporation. For purposes of this subject, a domestic corporation which owns at least 10 percent of the voting stock of a foreign corporation
from which itreceives dividends in any taxable year shall

xxx xxx xxx

(2) to the extent such dividends are paid by such foreign corporation out of accumulated profits [as defined in subsection (c) (1) (b)] of a year for which such foreign corporation is a less
developed country corporation, be deemed to have paid the same proportion of any income, war profits, or excess profits taxes paid or deemed to be paid by such foreign corporation to
any foreign country or to any possession of the United States on or with respect to such accumulated profits, which the amount of such dividends bears to the amount of such
accumulated profits.

xxx xxx xxx

(c) Applicable Rules

(1) Accumulated profits defined. For purposes of this section, the term "accumulated profits" means with respect to any foreign corporation,

(A) for purposes of subsections (a) (1) and (b) (1), the amount of its gains, profits, or income computed without reduction by the amount of the income, war profits, and
excess profits taxes imposed on or with respect to such profits or income by any foreign country. . . .; and

(B) for purposes of subsections (a) (2) and (b) (2), the amount of its gains, profits, or income in excess of the income, war profits, and excess profits taxes imposed on or
with respect to suchprofits or income.

The Secretary or his delegate shall have full power to determine from the accumulated profits of what year or years such dividends were paid, treating dividends paid in the first 20 days
of any year as having been paid from the accumulated profits of the preceding year or years (unless to his satisfaction shows otherwise), and in other respects treating dividends as
having been paid from the most recently accumulated gains, profits, or earning. . . . (Emphasis supplied)

Close examination of the above quoted provisions of the US Tax Code 7

shows the following:

a. US law (Section 901, Tax Code) grants P&G-USA a tax credit for the amount of the dividend tax actually paid
(i.e., withheld) from the dividend remittances to P&G-USA;

8 for a proportionate part of the corporate income tax

b. US law (Section 902, US Tax Code) grants to P&G-USA a "deemed paid' tax credit
actually paid to the Philippines by P&G-Phil.

The parent-corporation P&G-USA is "deemed to have paid" a portion of the Philippine corporate income taxalthough that tax was actually paid by its Philippine subsidiary, P&G-Phil., not by P&G-USA.
This "deemed paid" concept merely reflects economic reality, since the Philippine corporate income tax was in fact paid and deducted from revenues earned in the Philippines, thus reducing the
amount remittable as dividends to P&G-USA. In other words, US tax law treats the Philippine corporate income tax as if it came out of the pocket, as it were, of P&G-USA as a part of the economic cost
of carrying on business operations in the Philippines through the medium of P&G-Phil. and here earning profits. What is, under US law, deemed paid by P&G- USA are not "phantom taxes" but
instead Philippine corporate income taxes actually paid here by P&G-Phil., which are very real indeed.

It is also useful to note that both (i) the tax credit for the Philippine dividend tax actually withheld, and (ii) the tax credit for the Philippine corporate income tax actually paid by P&G Phil. but "deemed
paid" by P&G-USA, are tax credits available or applicable against the US corporate income tax of P&G-USA. These tax credits are allowed because of the US congressional desire to avoid or reduce
double taxation of the same income stream. 9

In order to determine whether US tax law complies with the requirements for applicability of the reduced or preferential fifteen percent (15%) dividend tax rate under Section 24 (b) (1), NIRC, it is
necessary:

a. to determine the amount of the 20 percentage points dividend tax waived by the Philippine government under Section 24 (b) (1), NIRC, and which hence goes to P&G-USA;

b. to determine the amount of the "deemed paid" tax credit which US tax law must allow to P&G-USA; and

c. to ascertain that the amount of the "deemed paid" tax credit allowed by US law is at least equal to the amount of the dividend tax waived by the Philippine Government.

Amount (a), i.e., the amount of the dividend tax waived by the Philippine government is arithmetically determined in the following manner:

P100.00 Pretax net corporate income earned by P&G-Phil.

x 35% Regular Philippine corporate income tax rate

 P35.00 Paid to the BIR by P&G-Phil. as Philippine
corporate income tax.

P100.00
-35.00

P65.00 Available for remittance as dividends to P&G-USA

P65.00 Dividends remittable to P&G-USA

x 35% Regular Philippine dividend tax rate under Section 24
(b) (1), NIRC
P22.75 Regular dividend tax

P65.00 Dividends remittable to P&G-USA

x 15% Reduced dividend tax rate under Section 24 (b) (1), NIRC

P9.75 Reduced dividend tax

P22.75 Regular dividend tax under Section 24 (b) (1), NIRC

-9.75 Reduced dividend tax under Section 24 (b) (1), NIRC

P13.00 Amount of dividend tax waived by Philippine
===== government under Section 24 (b) (1), NIRC.

Thus, amount (a) above is P13.00 for every P100.00 of pre-tax net income earned by P&G-Phil. Amount (a) is also the minimum amount of the "deemed paid" tax credit that US tax law shall allow if
P&G-USA is to qualify for the reduced or preferential dividend tax rate under Section 24 (b) (1), NIRC.

Amount (b) above, i.e., the amount of the "deemed paid" tax credit which US tax law allows under Section 902, Tax Code, may be computed arithmetically as follows:

P65.00 Dividends remittable to P&G-USA

- 9.75 Dividend tax withheld at the reduced (15%) rate

P55.25 Dividends actually remitted to P&G-USA

P35.00 Philippine corporate income tax paid by P&G-Phil.

to the BIR

Dividends actually
remitted by P&G-Phil.
to P&G-USA P55.25
= x P35.00 = P29.75 10
Amount of accumulated P65.00 ======
profits earned by
P&G-Phil. in excess
of income tax

Thus, for every P55.25 of dividends actually remitted (after withholding at the rate of 15%) by P&G-Phil. to its US parent P&G-USA, a tax credit of P29.75 is allowed by Section 902 US Tax Code for
Philippine corporate income tax "deemed paid" by the parent but actually paid by the wholly-owned subsidiary.

Since P29.75 is much higher than P13.00 (the amount of dividend tax waived by the Philippine government), Section 902, US Tax Code, specifically and clearly complies with the requirements of Section
24 (b) (1), NIRC.

3. It is important to note also that the foregoing reading of Sections 901 and 902 of the US Tax Code is identical with the reading of the BIR of Sections 901 and 902 of the US Tax Code is identical with
the reading of the BIR of Sections 901 and 902 as shown by administrative rulings issued by the BIR.

The first Ruling was issued in 1976, i.e., BIR Ruling No. 76004, rendered by then Acting Commissioner of Intemal Revenue Efren I. Plana, later Associate Justice of this Court, the relevant portion of
which stated:

However, after a restudy of the decision in the American Chicle Company case and the provisions of Section 901 and 902 of the U.S. Internal Revenue Code, we find merit in your
contention that our computation of the credit which the U.S. tax law allows in such cases is erroneous as the amount of tax "deemed paid" to the Philippine government for purposes of
credit against the U.S. tax by the recipient of dividends includes a portion of the amount of income tax paid by the corporation declaring the dividend in addition to the tax withheld from
the dividend remitted. In other words, the U.S. government will allow a credit to the U.S. corporation or recipient of the dividend, in addition to the amount of tax actually withheld, a
portion of the income tax paid by the corporation declaring the dividend. Thus, if a Philippine corporation wholly owned by a U.S. corporation has a net income of P100,000, it will pay
P25,000 Philippine income tax thereon in accordance with Section 24(a) of the Tax Code. The net income, after income tax, which is P75,000, will then be declared as dividend to the U.S.
 corporation at 15% tax, or P11,250, will be withheld therefrom. Under the aforementioned sections of the U.S. Internal Revenue Code, U.S. corporation receiving the dividend can utilize
as credit against its U.S. tax payable on said dividends the amount of P30,000 composed of:

(1) The tax "deemed paid" or indirectly paid on the dividend arrived at as follows:

P75,000 x P25,000 = P18,750

100,000 **

(2) The amount of 15% of

P75,000 withheld = 11,250

P30,000

The amount of P18,750 deemed paid and to be credited against the U.S. tax on the dividends received by the U.S. corporation from a Philippine subsidiary is clearly more than 20%
requirement ofPresidential Decree No. 369 as 20% of P75,000.00 the dividends to be remitted under the above example, amounts to P15,000.00 only.

In the light of the foregoing, BIR Ruling No. 75-005 dated September 10, 1975 is hereby amended in the sense that the dividends to be remitted by your client to its parent company shall
be subject to the withholding tax at the rate of 15% only.

This ruling shall have force and effect only for as long as the present pertinent provisions of the U.S. Federal Tax Code, which are the bases of the ruling, are not revoked, amended and
modified, the effect of which will reduce the percentage of tax deemed paid and creditable against the U.S. tax on dividends remitted by a foreign corporation to a U.S. corporation.
(Emphasis supplied)

The 1976 Ruling was reiterated in, e.g., BIR Ruling dated 22 July 1981 addressed to Basic Foods Corporation and BIR Ruling dated 20 October 1987 addressed to Castillo, Laman, Tan and Associates. In
other words, the 1976 Ruling of Hon. Efren I. Plana was reiterated by the BIR even as the case at bar was pending before the CTA and this Court.

4. We should not overlook the fact that the concept of "deemed paid" tax credit, which is embodied in Section 902, US Tax Code, is exactly the same "deemed paid" tax credit found in our NIRC and
which Philippine tax law allows to Philippine corporations which have operations abroad (say, in the United States) and which, therefore, pay income taxes to the US government.

Section 30 (c) (3) and (8), NIRC, provides:

(d) Sec. 30. Deductions from Gross Income.In computing net income, there shall be allowed as deductions . . .

(c) Taxes. . . .

xxx xxx xxx

(3) Credits against tax for taxes of foreign countries. If the taxpayer signifies in his return his desire to have the benefits of this paragraphs, the tax imposed by this Title shall be
credited with . . .

(a) Citizen and Domestic Corporation. In the case of a citizen of the Philippines and of domestic corporation, the amount of net income, war profits or excess profits, taxes paid or
accrued during the taxable year to any foreign country. (Emphasis supplied)

Under Section 30 (c) (3) (a), NIRC, above, the BIR must give a tax credit to a Philippine corporation for taxes actually paid by it to the US governmente.g., for taxes collected by the US government on
dividend remittances to the Philippine corporation. This Section of the NIRC is the equivalent of Section 901 of the US Tax Code.

Section 30 (c) (8), NIRC, is practically identical with Section 902 of the US Tax Code, and provides as follows:

(8) Taxes of foreign subsidiary. For the purposes of this subsection a domestic corporation which owns a majority of the voting stock of a foreign corporation from which it receives
dividends in any taxable year shall be deemed to have paid the same proportion of any income, war-profits, or excess-profits taxes paid by such foreign corporation to any foreign country,
upon or with respect to the accumulated profits of such foreign corporation from which such dividends were paid, which the amount of such dividends bears to the amount of such
accumulated profits: Provided, That the amount of tax deemed to have been paid under this subsection shall in no case exceed the same proportion of the tax against which credit is
taken which the amount of such dividends bears to the amount of the entire net income of the domestic corporation in which such dividends are included. The term"accumulated
profits" when used in this subsection reference to a foreign corporation, means the amount of its gains, profits, or income in excess of the income, war-profits, and excess-profits taxes
imposed upon or with respect to such profits or income; and the Commissioner of Internal Revenue shall have full power to determine from the accumulated profits of what year or years
such dividends were paid; treating dividends paid in the first sixty days of any year as having been paid from the accumulated profits of the preceding year or years (unless to his
satisfaction shown otherwise), and in other respects treating dividends as having been paid from the most recently accumulated gains, profits, or earnings. In the case of a foreign
corporation, the income, war-profits, and excess-profits taxes of which are determined on the basis of an accounting period of less than one year, the word "year" as used in this
subsection shall be construed to mean such accounting period. (Emphasis supplied)

Under the above quoted Section 30 (c) (8), NIRC, the BIR must give a tax credit to a Philippine parent corporation for taxes "deemed paid" by it, that is, e.g., for taxes paid to the US by the US subsidiary
of a Philippine-parent corporation. The Philippine parent or corporate stockholder is "deemed" under our NIRC to have paid a proportionate part of the US corporate income tax paid by its US
subsidiary, although such US tax was actually paid by the subsidiary and not by the Philippine parent.

Clearly, the "deemed paid" tax credit which, under Section 24 (b) (1), NIRC, must be allowed by US law to P&G-USA, is the same "deemed paid" tax credit that Philippine law allows to a Philippine corporation with a
wholly- or majority-owned subsidiary in (for instance) the US. The "deemed paid" tax credit allowed in Section 902, US Tax Code, is no more a credit for "phantom taxes" than is the "deemed paid" tax credit granted
in Section 30 (c) (8), NIRC.
 III

1. The Second Division of the Court, in holding that the applicable dividend tax rate in the instant case was the regular thirty-five percent (35%) rate rather than the reduced rate of fifteen percent (15%), held that
P&G-Phil. had failed to prove that its parent, P&G-USA, had in fact been given by the US tax authorities a "deemed paid" tax credit in the amount required by Section 24 (b) (1), NIRC.

We believe, in the first place, that we must distinguish between the legal question before this Court from questions of administrative implementation arising after the legal question has been answered. The basic
legal issue is of course, this: which is the applicable dividend tax rate in the instant case: the regular thirty-five percent (35%) rate or the reduced fifteen percent (15%) rate? The question of whether or not P&G-USA
is in fact given by the US tax authorities a "deemed paid" tax credit in the required amount, relates to the administrative implementation of the applicable reduced tax rate.

In the second place, Section 24 (b) (1), NIRC, does not in fact require that the "deemed paid" tax credit shall have actually been granted before the applicable dividend tax rate goes down from thirty-five percent
(35%) to fifteen percent (15%). As noted several times earlier, Section 24 (b) (1), NIRC, merely requires, in the case at bar, that the USA "shall allow a credit against the
tax due from [P&G-USA for] taxes deemed to have been paid in the Philippines . . ." There is neither statutory provision nor revenue regulation issued by the Secretary of Finance requiring the actual grant of the
"deemed paid" tax credit by the US Internal Revenue Service to P&G-USA before the preferential fifteen percent (15%) dividend rate becomes applicable. Section 24 (b) (1), NIRC, does not create a tax exemption nor
does it provide a tax credit; it is a provision which specifies when a particular (reduced) tax rate is legally applicable.

In the third place, the position originally taken by the Second Division results in a severe practical problem of administrative circularity. The Second Division in effect held that the reduced dividend tax rate is not
applicable until the US tax credit for "deemed paid" taxes is actually given in the required minimum amount by the US Internal Revenue Service to P&G-USA. But, the US "deemed paid" tax credit cannot be given by
the US tax authorities unless dividends have actually been remitted to the US, which means that the Philippine dividend tax, at the rate here applicable, was actually imposed and collected. 11
It is this
practical or operating circularity that is in fact avoided by our BIR when it issues rulings that the tax laws of particular foreign jurisdictions (e.g.,
12 13 14
Republic of Vanuatu Hongkong, Denmark, etc.) comply with the requirements set out in Section 24 (b) (1), NIRC, for applicability of the
fifteen percent (15%) tax rate. Once such a ruling is rendered, the Philippine subsidiary begins to withhold at the reduced dividend tax rate.

A requirement relating to administrative implementation is not properly imposed as a condition for the applicability, as a matter of law, of a
particular tax rate. Upon the other hand, upon the determination or recognition of the applicability of the reduced tax rate, there is nothing to
prevent the BIR from issuing implementing regulations that would require P&G Phil., or any Philippine corporation similarly situated, to certify
to the BIR the amount of the "deemed paid" tax credit actually subsequently granted by the US tax authorities to P&G-USA or a US parent
corporation for the taxable year involved. Since the US tax laws can and do change, such implementing regulations could also provide that
failure of P&G-Phil. to submit such certification within a certain period of time, would result in the imposition of a deficiency assessment for the
twenty (20) percentage points differential. The task of this Court is to settle which tax rate is applicable, considering the state of US law at a
given time. We should leave details relating to administrative implementation where they properly belong with the BIR.

2. An interpretation of a tax statute that produces a revenue flow for the government is not, for that reason alone, necessarily the correct
reading of the statute. There are many tax statutes or provisions which are designed, not to trigger off an instant surge of revenues, but rather
to achieve longer-term and broader-gauge fiscal and economic objectives. The task of our Court is to give effect to the legislative design and
objectives as they are written into the statute even if, as in the case at bar, some revenues have to be foregone in that process.

The economic objectives sought to be achieved by the Philippine Government by reducing the thirty-five percent (35%) dividend rate to fifteen
percent (15%) are set out in the preambular clauses of P.D. No. 369 which amended Section 24 (b) (1), NIRC, into its present form:

WHEREAS, it is imperative to adopt measures responsive to the requirements of a developing economyforemost of which is
the financing of economic development programs;

WHEREAS, nonresident foreign corporations with investments in the Philippines are taxed on their earnings from dividends at the
rate of 35%;

WHEREAS, in order to encourage more capital investment for large projects an appropriate tax need be imposed on dividends
received by non-resident foreign corporations in the same manner as the tax imposed on interest on foreign loans;

xxx xxx xxx

(Emphasis supplied)

More simply put, Section 24 (b) (1), NIRC, seeks to promote the in-flow of foreign equity investment in the Philippines by reducing the tax cost
of earning profits here and thereby increasing the net dividends remittable to the investor. The foreign investor, however, would not benefit
from the reduction of the Philippine dividend tax rate unless its home country gives it some relief from double taxation (i.e., second-tier
taxation) (the home country would simply have more "post-R.P. tax" income to subject to its own taxing power) by allowing the investor
additional tax credits which would be applicable against the tax payable to such home country. Accordingly, Section 24 (b) (1), NIRC, requires
the home or domiciliary country to give the investor corporation a "deemed paid" tax credit at least equal in amount to the twenty (20)
percentage points of dividend tax foregone by the Philippines, in the assumption that a positive incentive effect would thereby be felt by the
investor.

The net effect upon the foreign investor may be shown arithmetically in the following manner:

P65.00 Dividends remittable to P&G-USA (please

see page 392 above
- 9.75 Reduced R.P. dividend tax withheld by P&G-Phil.

P55.25 Dividends actually remitted to P&G-USA
 P55.25
x 46% Maximum US corporate income tax rate

P25.415US corporate tax payable by P&G-USA
without tax credits

P25.415
- 9.75 US tax credit for RP dividend tax withheld by P&G-Phil.
at 15% (Section 901, US Tax Code)

P15.66 US corporate income tax payable after Section 901
tax credit.

P55.25
- 15.66

P39.59 Amount received by P&G-USA net of R.P. and U.S.
===== taxes without "deemed paid" tax credit.

P25.415
- 29.75 "Deemed paid" tax credit under Section 902 US
Tax Code (please see page 18 above)

- 0 - US corporate income tax payable on dividends

====== remitted by P&G-Phil. to P&G-USA after
Section 902 tax credit.

P55.25 Amount received by P&G-USA net of RP and US

====== taxes after Section 902 tax credit.

It will be seen that the "deemed paid" tax credit allowed by Section 902, US Tax Code, could offset the US corporate income tax payable on the
dividends remitted by P&G-Phil. The result, in fine, could be that P&G-USA would after US tax credits, still wind up with P55.25, the full amount
of the dividends remitted to P&G-USA net of Philippine taxes. In the calculation of the Philippine Government, this should encourage additional
investment or re-investment in the Philippines by P&G-USA.

15
3. It remains only to note that under the Philippines-United States Convention "With Respect to Taxes on Income," the Philippines, by a treaty
commitment, reduced the regular rate of dividend tax to a maximum of twenty percent (20%) of the gross amount of dividends paid to US
parent corporations:

Art 11. Dividends

xxx xxx xxx

(2) The rate of tax imposed by one of the Contracting States on dividends derived from sources within that Contracting State by a
resident of the other Contracting State shall not exceed

(a) 25 percent of the gross amount of the dividend; or

(b) When the recipient is a corporation, 20 percent of the gross amount of the dividend if during the part of the paying corporation's
taxable year which precedes the date of payment of the dividend and during the whole of its prior taxable year (if any), at least 10
percent of the outstanding shares of the voting stock of the paying corporation was owned by the recipient corporation.

xxx xxx xxx

(Emphasis supplied)

The Tax Convention, at the same time, established a treaty obligation on the part of the United States that it "shall allow" to a US parent
corporation receiving dividends from its Philippine subsidiary "a [tax] credit for the appropriate amount of taxes paid or accrued to the
16
Philippines by the Philippine [subsidiary] . This is, of course, precisely the "deemed paid" tax credit provided for in Section 902, US Tax
Code, discussed above. Clearly, there is here on the part of the Philippines a deliberate undertaking to reduce the regular dividend tax rate of
twenty percent (20%) is a maximum rate, there is still a differential or additional reduction of five (5) percentage points which compliance of US
law (Section 902) with the requirements of Section 24 (b) (1), NIRC, makes available in respect of dividends from a Philippine subsidiary.

We conclude that private respondent P&G-Phil, is entitled to the tax refund or tax credit which it seeks.

WHEREFORE, for all the foregoing, the Court Resolved to GRANT private respondent's Motion for Reconsideration dated 11 May 1988, to SET
ASIDE the Decision of the and Division of the Court promulgated on 15 April 1988, and in lieu thereof, to REINSTATE and AFFIRM the Decision of
the Court of Tax Appeals in CTA Case No. 2883 dated 31 January 1984 and to DENY the Petition for Review for lack of merit. No pronouncement
as to costs.
G.R. No. L-68375 April 15, 1988

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
WANDER PHILIPPINES, INC. AND THE COURT OF TAX APPEALS, respondents.

The Solicitor General for petitioner.

Felicisimo R. Quiogue and Cirilo P. Noel for respondents.

BIDIN, J.:

This is a petition for review on certiorari of the January 19, 1984 Decision of the Court of Tax Appeals * in C.T.A. Case No.2884, entitled Wander
Philippines, Inc. vs. Commissioner of Internal Revenue, holding that Wander Philippines, Inc. is entitled to the preferential rate of 15%
withholding tax on the dividends remitted to its foreign parent company, the Glaro S.A. Ltd. of Switzerland, a non-resident foreign corporation.

Herein private respondent, Wander Philippines, Inc. (Wander, for short), is a domestic corporation organized under Philippine laws. It is wholly-
owned subsidiary of the Glaro S.A. Ltd. (Glaro for short), a Swiss corporation not engaged in trade or business in the Philippines.

On July 18, 1975, Wander filed its withholding tax return for the second quarter ending June 30, 1975 and remitted to its parent company,
Glaro dividends in the amount of P222,000.00, on which 35% withholding tax thereof in the amount of P77,700.00 was withheld and paid to
the Bureau of Internal Revenue.

Again, on July 14, 1976, Wander filed a withholding tax return for the second quarter ending June 30, 1976 on the dividends it remitted to
Glaro amounting to P355,200.00, on wich 35% tax in the amount of P124,320.00 was withheld and paid to the Bureau of Internal Revenue.

On July 5, 1977, Wander filed with the Appellate Division of the Internal Revenue a claim for refund and/or tax credit in the amount of
P115,400.00, contending that it is liable only to 15% withholding tax in accordance with Section 24 (b) (1) of the Tax Code, as amended by
Presidential Decree Nos. 369 and 778, and not on the basis of 35% which was withheld and paid to and collected by the government.

Petitioner herein, having failed to act on the above-said claim for refund, on July 15, 1977, Wander filed a petition with respondent Court of Tax
Appeals.

On October 6, 1977, petitioner file his Answer.

On January 19, 1984, respondent Court of Tax Appeals rendered a Decision, the decretal portion of which reads:

WHEREFORE, respondent is hereby ordered to grant a refund and/or tax credit to petitioner in the amount of P115,440.00
representing overpaid withholding tax on dividends remitted by it to the Glaro S.A. Ltd. of Switzerland during the second
quarter of the years 1975 and 1976.

On March 7, 1984, petitioner filed a Motion for Reconsideration but the same was denied in a Resolution dated August 13, 1984. Hence, the
instant petition.

Petitioner raised two (2) assignment of errors, to wit:

ASSUMING THAT THE TAX REFUND IN THE CASE AT BAR IS ALLOWABLE AT ALL, THE COURT OF TAX APPEALS ERRED INHOLDING THAT THE
HEREIN RESPONDENT WANDER PHILIPPINES, INC. IS ENTITLED TO THE SAID REFUND.

II

THE COURT OF TAX APPEALS ERRED IN HOLDING THAT SWITZERLAND, THE HOME COUNTRY OF GLARO S.A. LTD. (THE PARENT COMPANY OF
THE HEREIN RESPONDENT WANDER PHILIPPINES, INC.), GRANTS TO SAID GLARO S.A. LTD. AGAINST ITS SWISS INCOME TAX LIABILITY A TAX
CREDIT EQUIVALENT TO THE 20 PERCENTAGE-POINT PORTION (OF THE 35 PERCENT PHILIPPINE DIVIDEND TAX) SPARED OR WAIVED OR
OTHERWISE DEEMED AS IF PAID IN THE PHILIPPINES UNDER SECTION 24 (b) (1) OF THE PHILIPPINE TAX CODE.

The sole issue in this case is whether or not private respondent Wander is entitled to the preferential rate of 15% withholding tax on dividends
declared and remitted to its parent corporation, Glaro.
From this issue, two questions were posed by petitioner: (1) Whether or not Wander is the proper party to claim the refund; and (2) Whether
or not Switzerland allows as tax credit the "deemed paid" 20% Philippine Tax on such dividends.

Petitioner maintains and argues that it is Glaro the tax payer, and not Wander, the remitter or payor of the dividend income and a mere
withholding agent for and in behalf of the Philippine Government, which should be legally entitled to receive the refund if any.

It will be noted, however, that Petitioner's above-entitled argument is being raised for the first time in this Court. It was never raised at the
administrative level, or at the Court of Tax Appeals. To allow a litigant to assume a different posture when he comes before the court and
challenge the position he had accepted at the administrative level, would be to sanction a procedure whereby the Courtwhich is supposed to
review administrative determinationswould not review, but determine and decide for the first time, a question not raised at the
administrative forum. Thus, it is well settled that under the same underlying principle of prior exhaustion of administrative remedies, on the
judicial level, issues not raised in the lower court cannot be raised for the first time on appeal (Aguinaldo Industries Corporation vs.
Commissioner of Internal Revenue, 112 SCRA 136; Pampanga Sugar Dev. Co., Inc. vs. CIR, 114 SCRA 725; Garcia vs. Court of Appeals, 102 SCRA
597; Matialonzo vs. Servidad, 107 SCRA 726,

In any event, the submission of petitioner that Wander is but a withholding agent of the government and therefore cannot claim
reimbursement of the alleged overpaid taxes, is untenable. It will be recalled, that said corporation is first and foremost a wholly owned
subsidiary of Glaro. The fact that it became a withholding agent of the government which was not by choice but by compulsion under Section
53 (b) of the Tax Code, cannot by any stretch of the imagination be considered as an abdication of its responsibility to its mother company.
Thus, this Court construing Section 53 (b) of the Internal Revenue Code held that "the obligation imposed thereunder upon the withholding
agent is compulsory." It is a device to insure the collection by the Philippine Government of taxes on incomes, derived from sources in the
Philippines, by aliens who are outside the taxing jurisdiction of this Court (Commissioner of Internal Revenue vs. Malayan Insurance Co., Inc., 21
SCRA 944). In fact, Wander may be assessed for deficiency withholding tax at source, plus penalties consisting of surcharge and interest
(Section 54, NLRC). Therefore, as the Philippine counterpart, Wander is the proper entity who should for the refund or credit of overpaid
withholding tax on dividends paid or remitted by Glaro.

Closely intertwined with the first assignment of error is the issue of whether or not Switzerland, the foreign country where Glaro is domiciled,
grants to Glaro a tax credit against the tax due it, equivalent to 20%, or the difference between the regular 35% rate of the preferential 15%
rate. The dispute in this issue lies on the fact that Switzerland does not impose any income tax on dividends received by Swiss corporation from
corporations domiciled in foreign countries.

Section 24 (b) (1) of the Tax Code, as amended by P.D. 369 and 778, the law involved in this case, reads:

Sec. 1. The first paragraph of subsection (b) of Section 24 of the National Internal Revenue Code, as amended, is hereby
further amended to read as follows:

(b) Tax on foreign corporations. 1) Non-resident corporation. A foreign corporation not engaged in
trade or business in the Philippines, including a foreign life insurance company not engaged in the life
insurance business in the Philippines, shall pay a tax equal to 35% of the gross income received during
its taxable year from all sources within the Philippines, as interest (except interest on foreign loans
which shall be subject to 15% tax), dividends, premiums, annuities, compensations, remuneration for
technical services or otherwise, emoluments or other fixed or determinable, annual, periodical or casual
gains, profits, and income, and capital gains: ... Provided, still further That on dividends received from a
domestic corporation liable to tax under this Chapter, the tax shall be 15% of the dividends received,
which shall be collected and paid as provided in Section 53 (d) of this Code, subject to the condition that
the country in which the non-resident foreign corporation is domiciled shall allow a credit against the
tax due from the non-resident foreign corporation taxes deemed to have been paid in the Philippines
equivalent to 20% which represents the difference between the regular tax (35%) on corporations and
the tax (15%) dividends as provided in this section: ...

From the above-quoted provision, the dividends received from a domestic corporation liable to tax, the tax shall be 15% of the dividends
received, subject to the condition that the country in which the non-resident foreign corporation is domiciled shall allow a credit against the tax
due from the non-resident foreign corporation taxes deemed to have been paid in the Philippines equivalent to 20% which represents the
difference between the regular tax (35%) on corporations and the tax (15%) dividends.

In the instant case, Switzerland did not impose any tax on the dividends received by Glaro. Accordingly, Wander claims that full credit is
granted and not merely credit equivalent to 20%. Petitioner, on the other hand, avers the tax sparing credit is applicable only if the country of
the parent corporation allows a foreign tax credit not only for the 15 percentage-point portion actually paid but also for the equivalent twenty
percentage point portion spared, waived or otherwise deemed as if paid in the Philippines; that private respondent does not cite anywhere a
Swiss law to the effect that in case where a foreign tax, such as the Philippine 35% dividend tax, is spared waived or otherwise considered as if
paid in whole or in part by the foreign country, a Swiss foreign-tax credit would be allowed for the whole or for the part, as the case may be, of
the foreign tax so spared or waived or considered as if paid by the foreign country.

While it may be true that claims for refund are construed strictly against the claimant, nevertheless, the fact that Switzerland did not impose
any tax or the dividends received by Glaro from the Philippines should be considered as a full satisfaction of the given condition. For, as aptly
stated by respondent Court, to deny private respondent the privilege to withhold only 15% tax provided for under Presidential Decree No. 369,
amending Section 24 (b) (1) of the Tax Code, would run counter to the very spirit and intent of said law and definitely will adversely affect
foreign corporations" interest here and discourage them from investing capital in our country.

Besides, it is significant to note that the conclusion reached by respondent Court is but a confirmation of the May 19, 1977 ruling of petitioner
that "since the Swiss Government does not impose any tax on the dividends to be received by the said parent corporation in the Philippines,
the condition imposed under the above-mentioned section is satisfied. Accordingly, the withholding tax rate of 15% is hereby affirmed."
Moreover, as a matter of principle, this Court will not set aside the conclusion reached by an agency such as the Court of Tax Appeals which is,
by the very nature of its function, dedicated exclusively to the study and consideration of tax problems and has necessarily developed an
expertise on the subject unless there has been an abuse or improvident exercise of authority (Reyes vs. Commissioner of Internal Revenue, 24
SCRA 198, which is not present in the instant case.

WHEREFORE, the petition filed is DISMISSED for lack of merit.

SO ORDERED.

G.R. No. 127105 June 25, 1999

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
S.C. JOHNSON AND SON, INC., and COURT OF APPEALS, respondents.

GONZAGA-REYES, J.:

This is a petition for review on certiorari under Rule 45 of the Rules of Court seeking to set aside the decision of the Court of Appeals dated
November 7, 1996 in CA-GR SP No. 40802 affirming the decision of the Court of Tax Appeals in CTA Case No. 5136.

The antecedent facts as found by the Court of Tax Appeals are not disputed, to wit:

[Respondent], a domestic corporation organized and operating under the Philippine laws, entered into a license agreement
with SC Johnson and Son, United States of America (USA), a non-resident foreign corporation based in the U.S.A. pursuant
to which the [respondent] was granted the right to use the trademark, patents and technology owned by the latter
including the right to manufacture, package and distribute the products covered by the Agreement and secure assistance in
management, marketing and production from SC Johnson and Son, U. S. A.

The said License Agreement was duly registered with the Technology Transfer Board of the Bureau of Patents, Trade Marks
and Technology Transfer under Certificate of Registration No. 8064 (Exh. "A").

For the use of the trademark or technology, [respondent] was obliged to pay SC Johnson and Son, USA royalties based on a
percentage of net sales and subjected the same to 25% withholding tax on royalty payments which [respondent] paid for
the period covering July 1992 to May 1993 in the total amount of P1,603,443.00 (Exhs. "B" to "L" and submarkings).

On October 29, 1993, [respondent] filed with the International Tax Affairs Division (ITAD) of the BIR a claim for refund of
overpaid withholding tax on royalties arguing that, "the antecedent facts attending [respondent's] case fall squarely within
the same circumstances under which said MacGeorge and Gillete rulings were issued. Since the agreement was approved
by the Technology Transfer Board, the preferential tax rate of 10% should apply to the [respondent]. We therefore submit
that royalties paid by the [respondent] to SC Johnson and Son, USA is only subject to 10% withholding tax pursuant to the
most-favored nation clause of the RP-US Tax Treaty [Article 13 Paragraph 2 (b) (iii)] in relation to the RP-West Germany Tax
Treaty [Article 12 (2) (b)]" (Petition for Review [filed with the Court of Appeals], par. 12). [Respondent's] claim for there
fund of P963,266.00 was computed as follows:

Gross 25% 10%

Month/ Royalty Withholding Withholding

Year Fee Tax Paid Tax Balance

July 1992 559,878 139,970 55,988 83,982

August 567,935 141,984 56,794 85,190

September 595,956 148,989 59,596 89,393

October 634,405 158,601 63,441 95,161

 November 620,885 155,221 62,089 93,133

December 383,276 95,819 36,328 57,491

Jan 1993 602,451 170,630 68,245 102,368

February 565,845 141,461 56,585 84,877

March 547,253 136,813 54,725 82,088

April 660,810 165,203 66,081 99,122

May 603,076 150,769 60,308 90,461

1
P6,421,770 P1,605,443 P642,177 P963,266

======== ======== ======== ========

The Commissioner did not act on said claim for refund. Private respondent S.C. Johnson & Son, Inc. (S.C. Johnson) then filed a petition for
review before the Court of Tax Appeals (CTA) where the case was docketed as CTA Case No. 5136, to claim a refund of the overpaid
withholding tax on royalty payments from July 1992 to May 1993.

On May 7, 1996, the Court of Tax Appeals rendered its decision in favor of S.C. Johnson and ordered the Commissioner of Internal Revenue to
issue a tax credit certificate in the amount of P963,266.00 representing overpaid withholding tax on royalty payments, beginning July, 1992 to
2
May, 1993.

The Commissioner of Internal Revenue thus filed a petition for review with the Court of Appeals which rendered the decision subject of this
3
appeal on November 7, 1996 finding no merit in the petition and affirming in toto the CTA ruling.

This petition for review was filed by the Commissioner of Internal Revenue raising the following issue:

THE COURT OF APPEALS ERRED IN RULING THAT SC JOHNSON AND SON, USA IS ENTITLED TO THE "MOST FAVORED
NATION" TAX RATE OF 10% ON ROYALTIES AS PROVIDED IN THE RP-US TAX TREATY IN RELATION TO THE RP-WEST
GERMANY TAX TREATY.

Petitioner contends that under Article 13(2) (b) (iii) of the RP-US Tax Treaty, which is known as the "most favored nation" clause, the lowest
rate of the Philippine tax at 10% may be imposed on royalties derived by a resident of the United States from sources within the Philippines
only if the circumstances of the resident of the United States are similar to those of the resident of West Germany. Since the RP-US Tax Treaty
contains no "matching credit" provision as that provided under Article 24 of the RP-West Germany Tax Treaty, the tax on royalties under the
RP-US Tax Treaty is not paid under similar circumstances as those obtaining in the RP-West Germany Tax Treaty. Even assuming that the phrase
"paid under similar circumstances" refers to the payment of royalties, and not taxes, as held by the Court of Appeals, still, the "most favored
nation" clause cannot be invoked for the reason that when a tax treaty contemplates circumstances attendant to the payment of a tax, or
royalty remittances for that matter, these must necessarily refer to circumstances that are tax-related. Finally, petitioner argues that since S.C.
Johnson's invocation of the "most favored nation" clause is in the nature of a claim for exemption from the application of the regular tax rate of
25% for royalties, the provisions of the treaty must be construed strictly against it.

In its Comment, private respondent S.C. Johnson avers that the instant petition should be denied (1) because it contains a defective
certification against forum shopping as required under SC Circular No. 28-91, that is, the certification was not executed by the petitioner herself
but by her counsel; and (2) that the "most favored nation" clause under the RP-US Tax Treaty refers to royalties paid under similar
circumstances as those royalties subject to tax in other treaties; that the phrase "paid under similar circumstances" does not refer to payment
of the tax but to the subject matter of the tax, that is, royalties, because the "most favored nation" clause is intended to allow the taxpayer in
one state to avail of more liberal provisions contained in another tax treaty wherein the country of residence of such taxpayer is also a party
thereto, subject to the basic condition that the subject matter of taxation in that other tax treaty is the same as that in the original tax treaty
under which the taxpayer is liable; thus, the RP-US Tax Treaty speaks of "royalties of the same kind paid under similar circumstances". S.C.
Johnson also contends that the Commissioner is estopped from insisting on her interpretation that the phrase "paid under similar
circumstances" refers to the manner in which the tax is paid, for the reason that said interpretation is embodied in Revenue Memorandum
Circular ("RMC") 39-92 which was already abandoned by the Commissioner's predecessor in 1993; and was expressly revoked in BIR Ruling No.
052-95 which stated that royalties paid to an American licensor are subject only to 10% withholding tax pursuant to Art 13(2)(b)(iii) of the RP-
US Tax Treaty in relation to the RP-West Germany Tax Treaty. Said ruling should be given retroactive effect except if such is prejudicial to the
taxpayer pursuant to Section 246 of the National Internal Revenue Code.

Petitioner filed Reply alleging that the fact that the certification against forum shopping was signed by petitioner's counsel is not a fatal defect
as to warrant the dismissal of this petition since Circular No. 28-91 applies only to original actions and not to appeals, as in the instant case.
Moreover, the requirement that the certification should be signed by petitioner and not by counsel does not apply to petitioner who has only
the Office of the Solicitor General as statutory counsel. Petitioner reiterates that even if the phrase "paid under similar circumstances"
embodied in the most favored nation clause of the RP-US Tax Treaty refers to the payment of royalties and not taxes, still the presence or
absence of a "matching credit" provision in the said RP-US Tax Treaty would constitute a material circumstance to such payment and would be
determinative of the said clause's application.1wphi1.nt
We address first the objection raised by private respondent that the certification against forum shopping was not executed by the petitioner
herself but by her counsel, the Office of the Solicitor General (O.S.G.) through one of its Solicitors, Atty. Tomas M. Navarro.

SC Circular No. 28-91 provides:

SUBJECT: ADDITIONAL REQUISITES FOR PETITIONS FILED WITH

THE SUPREME COURT AND THE COURT OF APPEALS TO PREVENT
FORUM SHOPPING OR MULTIPLE FILING OF PETITIONS AND
COMPLAINTS

TO: xxx xxx xxx

The attention of the Court has been called to the filing of multiple petitions and complaints involving the same issues in the
Supreme Court, the Court of Appeals or other tribunals or agencies, with the result that said courts, tribunals or agencies
have to resolve the same issues.

(1) To avoid the foregoing, in every petition filed with the Supreme Court or the Court of Appeals, the petitioner aside from
complying with pertinent provisions of the Rules of Court and existing circulars, must certify under oath to all of the
following facts or undertakings: (a) he has not theretofore commenced any other action or proceeding involving the same
issues in the Supreme Court, the Court of Appeals, or any tribunal or
agency; . . .

(2) Any violation of this revised Circular will entail the following sanctions: (a) it shall be a cause for the summary dismissal
of the multiple petitions or complaints; . . .

The circular expressly requires that a certificate of non-forum shopping should be attached to petitions filed before this Court and the Court of
Appeals. Petitioner's allegation that Circular No. 28-91 applies only to original actions and not to appeals as in the instant case is not supported
by the text nor by the obvious intent of the Circular which is to prevent multiple petitions that will result in the same issue being resolved by
different courts.

Anent the requirement that the party, not counsel, must certify under oath that he has not commenced any other action involving the same
issues in this Court or the Court of Appeals or any other tribunal or agency, we are inclined to accept petitioner's submission that since the OSG
is the only lawyer for the petitioner, which is a government agency mandated under Section 35, Chapter 12, title III, Book IV of the 1987
4
Administrative Code to be represented only by the Solicitor General, the certification executed by the OSG in this case constitutes substantial
compliance with Circular No. 28-91.

With respect to the merits of this petition, the main point of contention in this appeal is the interpretation of Article 13 (2) (b) (iii) of the RP-US
Tax Treaty regarding the rate of tax to be imposed by the Philippines upon royalties received by a non-resident foreign corporation. The
provision states insofar as pertinent
that

1) Royalties derived by a resident of one of the Contracting States from sources within the other
Contracting State may be taxed by both Contracting States.

2) However, the tax imposed by that Contracting State shall not exceed.

a) In the case of the United States, 15 percent of the gross amount of the royalties,
and

b) In the case of the Philippines, the least of:

(i) 25 percent of the gross amount of the royalties;

(ii) 15 percent of the gross amount of the royalties, where the

royalties are paid by a corporation registered with the Philippine
Board of Investments and engaged in preferred areas of
activities; and

(iii) the lowest rate of Philippine tax that may be imposed on

royalties of the same kind paid under similar circumstances to a
resident of a third State.

xxx xxx xxx

(emphasis supplied)

Respondent S. C. Johnson and Son, Inc. claims that on the basis of the quoted provision, it is entitled to the concessional tax rate of 10 percent
on royalties based on Article 12 (2) (b) of the RP-Germany Tax Treaty which provides:

(2) However, such royalties may also be taxed in the Contracting State in which they arise, and
according to the law of that State, but the tax so charged shall not exceed:
 xxx xxx xxx

b) 10 percent of the gross amount of royalties arising from the use of, or the right to
use, any patent, trademark, design or model, plan, secret formula or process, or
from the use of or the right to use, industrial, commercial, or scientific equipment,
or for information concerning industrial, commercial or scientific experience.

For as long as the transfer of technology, under Philippine law, is subject to approval, the limitation of the tax rate
mentioned under b) shall, in the case of royalties arising in the Republic of the Philippines, only apply if the contract giving
rise to such royalties has been approved by the Philippine competent authorities.

Unlike the RP-US Tax Treaty, the RP-Germany Tax Treaty allows a tax credit of 20 percent of the gross amount of such royalties against German
income and corporation tax for the taxes payable in the Philippines on such royalties where the tax rate is reduced to 10 or 15 percent under
such treaty. Article 24 of the RP-Germany Tax Treaty states

1) Tax shall be determined in the case of a resident of the Federal Republic of Germany as follows:

xxx xxx xxx

b) Subject to the provisions of German tax law regarding credit for foreign tax, there
shall be allowed as a credit against German income and corporation tax payable in
respect of the following items of income arising in the Republic of the Philippines,
the tax paid under the laws of the Philippines in accordance with this Agreement on:

xxx xxx xxx

dd) royalties, as defined in paragraph 3 of Article 12;

xxx xxx xxx

c) For the purpose of the credit referred in subparagraph; b) the Philippine tax shall
be deemed to be

xxx xxx xxx

cc) in the case of royalties for which the tax is reduced to 10 or

15 per cent according to paragraph 2 of Article 12, 20 percent of
the gross amount of such royalties.

xxx xxx xxx

According to petitioner, the taxes upon royalties under the RP-US Tax Treaty are not paid under circumstances similar to those in the RP-West
Germany Tax Treaty since there is no provision for a 20 percent matching credit in the former convention and private respondent cannot
invoke the concessional tax rate on the strength of the most favored nation clause in the RP-US Tax Treaty. Petitioner's position is explained
thus:

Under the foregoing provision of the RP-West Germany Tax Treaty, the Philippine tax paid on income from sources within
the Philippines is allowed as a credit against German income and corporation tax on the same income. In the case of
royalties for which the tax is reduced to 10 or 15 percent according to paragraph 2 of Article 12 of the RP-West Germany
Tax Treaty, the credit shall be 20% of the gross amount of such royalty. To illustrate, the royalty income of a German
resident from sources within the Philippines arising from the use of, or the right to use, any patent, trade mark, design or
model, plan, secret formula or process, is taxed at 10% of the gross amount of said royalty under certain conditions. The
rate of 10% is imposed if credit against the German income and corporation tax on said royalty is allowed in favor of the
German resident. That means the rate of 10% is granted to the German taxpayer if he is similarly granted a credit against
the income and corporation tax of West Germany. The clear intent of the "matching credit" is to soften the impact of
double taxation by different jurisdictions.

The RP-US Tax Treaty contains no similar "matching credit" as that provided under the RP-West Germany Tax Treaty.
Hence, the tax on royalties under the RP-US Tax Treaty is not paid under similar circumstances as those obtaining in the RP-
West Germany Tax Treaty. Therefore, the "most favored nation" clause in the RP-West Germany Tax Treaty cannot be
5
availed of in interpreting the provisions of the RP-US Tax Treaty.

The petition is meritorious.

We are unable to sustain the position of the Court of Tax Appeals, which was upheld by the Court of Appeals, that the phrase "paid under
similar circumstances in Article 13 (2) (b), (iii) of the RP-US Tax Treaty should be interpreted to refer to payment of royalty, and not to the
payment of the tax, for the reason that the phrase "paid under similar circumstances" is followed by the phrase "to a resident of a third state".
The respondent court held that "Words are to be understood in the context in which they are used", and since what is paid to a resident of a
third state is not a tax but a royalty "logic instructs" that the treaty provision in question should refer to royalties of the same kind paid under
similar circumstances.
The above construction is based principally on syntax or sentence structure but fails to take into account the purpose animating the treaty
provisions in point. To begin with, we are not aware of any law or rule pertinent to the payment of royalties, and none has been brought to our
attention, which provides for the payment of royalties under dissimilar circumstances. The tax rates on royalties and the circumstances of
payment thereof are the same for all the recipients of such royalties and there is no disparity based on nationality in the circumstances of such
6
payment. On the other hand, a cursory reading of the various tax treaties will show that there is no similarity in the provisions on relief from or
7 8
avoidance of double taxation as this is a matter of negotiation between the contracting parties. As will be shown later, this dissimilarity is true
particularly in the treaties between the Philippines and the United States and between the Philippines and West Germany.

The RP-US Tax Treaty is just one of a number of bilateral treaties which the Philippines has entered into for the avoidance of double
9
taxation. The purpose of these international agreements is to reconcile the national fiscal legislations of the contracting parties in order to
10
help the taxpayer avoid simultaneous taxation in two different jurisdictions. More precisely, the tax conventions are drafted with a view
towards the elimination of international juridical double taxation, which is defined as the imposition of comparable taxes in two or more states
11
on the same taxpayer in respect of the same subject matter and for identical periods. The apparent rationale for doing away with double
taxation is of encourage the free flow of goods and services and the movement of capital, technology and persons between countries,
12
conditions deemed vital in creating robust and dynamic economies. Foreign investments will only thrive in a fairly predictable and reasonable
13
international investment climate and the protection against double taxation is crucial in creating such a climate.

Double taxation usually takes place when a person is resident of a contracting state and derives income from, or owns capital in, the other
contracting state and both states impose tax on that income or capital. In order to eliminate double taxation, a tax treaty resorts to several
methods. First, it sets out the respective rights to tax of the state of source or situs and of the state of residence with regard to certain classes
of income or capital. In some cases, an exclusive right to tax is conferred on one of the contracting states; however, for other items of income
14
or capital, both states are given the right to tax, although the amount of tax that may be imposed by the state of source is limited.

The second method for the elimination of double taxation applies whenever the state of source is given a full or limited right to tax together
with the state of residence. In this case, the treaties make it incumbent upon the state of residence to allow relief in order to avoid double
taxation. There are two methods of relief the exemption method and the credit method. In the exemption method, the income or capital
which is taxable in the state of source or situs is exempted in the state of residence, although in some instances it may be taken into account in
determining the rate of tax applicable to the taxpayer's remaining income or capital. On the other hand, in the credit method, although the
income or capital which is taxed in the state of source is still taxable in the state of residence, the tax paid in the former is credited against the
tax levied in the latter. The basic difference between the two methods is that in the exemption method, the focus is on the income or capital
15
itself, whereas the credit method focuses upon the tax.

In negotiating tax treaties, the underlying rationale for reducing the tax rate is that the Philippines will give up a part of the tax in the
expectation that the tax given up for this particular investment is not taxed by the other
16
country. Thus the petitioner correctly opined that the phrase "royalties paid under similar circumstances" in the most favored nation clause
of the US-RP Tax Treaty necessarily contemplated "circumstances that are tax-related".

In the case at bar, the state of source is the Philippines because the royalties are paid for the right to use property or rights, i.e. trademarks,
17
patents and technology, located within the Philippines. The United States is the state of residence since the taxpayer, S. C. Johnson and Son,
U. S. A., is based there. Under the RP-US Tax Treaty, the state of residence and the state of source are both permitted to tax the royalties, with
18
a restraint on the tax that may be collected by the state of source. Furthermore, the method employed to give relief from double taxation is
the allowance of a tax credit to citizens or residents of the United States (in an appropriate amount based upon the taxes paid or accrued to the
Philippines) against the United States tax, but such amount shall not exceed the limitations provided by United States law for the taxable
19
year. Under Article 13 thereof, the Philippines may impose one of three rates 25 percent of the gross amount of the royalties; 15 percent
when the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities;
or the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third
state.

Given the purpose underlying tax treaties and the rationale for the most favored nation clause, the concessional tax rate of 10 percent
provided for in the RP-Germany Tax Treaty should apply only if the taxes imposed upon royalties in the RP-US Tax Treaty and in the RP-
Germany Tax Treaty are paid under similar circumstances. This would mean that private respondent must prove that the RP-US Tax Treaty
grants similar tax reliefs to residents of the United States in respect of the taxes imposable upon royalties earned from sources within the
Philippines as those allowed to their German counterparts under the RP-Germany Tax Treaty.

The RP-US and the RP-West Germany Tax Treaties do not contain similar provisions on tax crediting. Article 24 of the RP-Germany Tax
Treaty, supra, expressly allows crediting against German income and corporation tax of 20% of the gross amount of royalties paid under the law
of the Philippines. On the other hand, Article 23 of the RP-US Tax Treaty, which is the counterpart provision with respect to relief for double
taxation, does not provide for similar crediting of 20% of the gross amount of royalties paid. Said Article 23 reads:

Article 23

Relief from double taxation

Double taxation of income shall be avoided in the following manner:

1) In accordance with the provisions and subject to the limitations of the law of the United States (as it
may be amended from time to time without changing the general principle thereof), the United States
shall allow to a citizen or resident of the United States as a credit against the United States tax the
appropriate amount of taxes paid or accrued to the Philippines and, in the case of a United States
corporation owning at least 10 percent of the voting stock of a Philippine corporation from which it
receives dividends in any taxable year, shall allow credit for the appropriate amount of taxes paid or
accrued to the Philippines by the Philippine corporation paying such dividends with respect to the
profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount
of tax paid or accrued to the Philippines, but the credit shall not exceed the limitations (for the purpose
 of limiting the credit to the United States tax on income from sources within the Philippines or on
income from sources outside the United States) provided by United States law for the taxable year. . . .

The reason for construing the phrase "paid under similar circumstances" as used in Article 13 (2) (b) (iii) of the RP-US Tax Treaty as referring to
taxes is anchored upon a logical reading of the text in the light of the fundamental purpose of such treaty which is to grant an incentive to the
foreign investor by lowering the tax and at the same time crediting against the domestic tax abroad a figure higher than what was collected in
the Philippines.

In one case, the Supreme Court pointed out that laws are not just mere compositions, but have ends to be achieved and that the general
20
purpose is a more important aid to the meaning of a law than any rule which grammar may lay down. It is the duty of the courts to look to
the object to be accomplished, the evils to be remedied, or the purpose to be subserved, and should give the law a reasonable or liberal
21
construction which will best effectuate its purpose. The Vienna Convention on the Law of Treaties states that a treaty shall be interpreted in
good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and
22
purpose.

As stated earlier, the ultimate reason for avoiding double taxation is to encourage foreign investors to invest in the Philippines a crucial
23
economic goal for developing countries. The goal of double taxation conventions would be thwarted if such treaties did not provide for
effective measures to minimize, if not completely eliminate, the tax burden laid upon the income or capital of the investor. Thus, if the rates of
tax are lowered by the state of source, in this case, by the Philippines, there should be a concomitant commitment on the part of the state of
24
residence to grant some form of tax relief, whether this be in the form of a tax credit or exemption. Otherwise, the tax which could have
been collected by the Philippine government will simply be collected by another state, defeating the object of the tax treaty since the tax
burden imposed upon the investor would remain unrelieved. If the state of residence does not grant some form of tax relief to the investor, no
benefit would redound to the Philippines, i.e., increased investment resulting from a favorable tax regime, should it impose a lower tax rate on
the royalty earnings of the investor, and it would be better to impose the regular rate rather than lose much-needed revenues to another
country.

At the same time, the intention behind the adoption of the provision on "relief from double taxation" in the two tax treaties in question should
be considered in light of the purpose behind the most favored nation clause.

The purpose of a most favored nation clause is to grant to the contracting party treatment not less favorable than that which has been or may
25
be granted to the "most favored" among other countries. The most favored nation clause is intended to establish the principle of equality of
international treatment by providing that the citizens or subjects of the contracting nations may enjoy the privileges accorded by either party
26
to those of the most favored nation. The essence of the principle is to allow the taxpayer in one state to avail of more liberal provisions
granted in another tax treaty to which the country of residence of such taxpayer is also a party provided that the subject matter of taxation, in
this case royalty income, is the same as that in the tax treaty under which the taxpayer is liable. Both Article 13 of the RP-US Tax Treaty and
Article 12 (2) (b) of the RP-West Germany Tax Treaty, above-quoted, speaks of tax on royalties for the use of trademark, patent, and
technology. The entitlement of the 10% rate by U.S. firms despite the absence of a matching credit (20% for royalties) would derogate from the
design behind the most grant equality of international treatment since the tax burden laid upon the income of the investor is not the same in
the two countries. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of most favored nation treatment
precisely to underscore the need for equality of treatment.

We accordingly agree with petitioner that since the RP-US Tax Treaty does not give a matching tax credit of 20 percent for the taxes paid to the
Philippines on royalties as allowed under the RP-West Germany Tax Treaty, private respondent cannot be deemed entitled to the 10 percent
rate granted under the latter treaty for the reason that there is no payment of taxes on royalties under similar circumstances.

It bears stress that tax refunds are in the nature of tax exemptions. As such they are regarded as in derogation of sovereign authority and to be
27
construed strictissimi juris against the person or entity claiming the exemption. The burden of proof is upon him who claims the exemption in
28
his favor and he must be able to justify his claim by the clearest grant of organic or statute law. Private respondent is claiming for a refund of
the alleged overpayment of tax on royalties; however, there is nothing on record to support a claim that the tax on royalties under the RP-US
Tax Treaty is paid under similar circumstances as the tax on royalties under the RP-West Germany Tax Treaty.

WHEREFORE, for all the foregoing, the instant petition is GRANTED. The decision dated May 7, 1996 of the Court of Tax Appeals and the
decision dated November 7, 1996 of the Court of Appeals are hereby SET ASIDE.

SO ORDERED.